Attached files
UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
Washington,
D.C. 20549
FORM
10-K
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þ
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ANNUAL REPORT
UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
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For
the fiscal year ended December 31, 2009
OR
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o
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TRANSITION
REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
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For the transition period
from
to
Commission file
number 001-33537
CHINA
SHENGHUO PHARMACEUTICAL HOLDINGS, INC.
(Exact
Name of Registrant as Specified in Its Charter)
Delaware
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20-2903562
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(State or Other Jurisdiction
of Incorporation or Organization)
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(IRS Employer
Identification No.)
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No. 2,
Jing You Road, Kunming National Economy & Technology Developing
District,
People’s
Republic of China 650217
(Address
of Principal Executive Offices) (Zip Code)
0086-871-728-2628
(Registrant’s
Telephone Number, Including Area Code)
SECURITIES
REGISTERED UNDER SECTION 12(b) OF THE EXCHANGE ACT:
Title
of Each Class
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Name
of Each Exchange on Which Registered
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Common
Stock, $0.0001 par value
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NYSE
Amex
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SECURITIES
REGISTERED UNDER SECTION 12(g) OF THE EXCHANGE ACT:
None.
Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined in
Rule 405 of the Securities Act. Yes o 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 o 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 o
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. o
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company. See
definitions of “large accelerated filer,” “accelerated filer” and “smaller
reporting company” in Rule 12b-2 of the Exchange Act.
Large Accelerated Filer ¨
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Accelerated Filer ¨
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Non-Accelerated Filer ¨
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Smaller Reporting Company þ
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Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Act). ¨ Yes þ No
The
aggregate market value of the registrant’s issued and outstanding shares of
common stock held by non-affiliates of the registrant as of June 30, 2009 (based
on the price at which the registrant’s common stock was last sold on such date)
was approximately $14,169,168.
The
number of shares outstanding of the registrant’s common stock as of
March 24, 2010 was 19,679,400.
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.
TABLE OF
CONTENTS
PART
I
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ITEM
1.
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BUSINESS.
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3
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ITEM
1A.
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RISK
FACTORS.
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15
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ITEM
1B.
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UNRESOLVED
STAFF COMMENTS.
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32
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ITEM
2.
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PROPERTIES.
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32
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ITEM
3.
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LEGAL
PROCEEDINGS.
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32
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ITEM
4.
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SUBMISSION
OF MATTERS TO A VOTE OF SECURITY HOLDERS.
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33
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PART
II
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ITEM
5.
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MARKET
FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER
PURCHASES OF EQUITY SECURITIES.
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34
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ITEM
6.
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SELECTED
FINANCIAL DATA.
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35
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ITEM
7.
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MANAGEMENT’S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS.
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36
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ITEM
7A.
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QUANTITATIVE
AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
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48
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ITEM
8.
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FINANCIAL
STATEMENTS AND SUPPLEMENTARY DATA.
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48
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ITEM
9.
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CHANGES
IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE.
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48
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ITEM
9A.
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CONTROLS
AND PROCEDURES.
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49
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ITEM
9B.
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OTHER
INFORMATION.
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51
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PART
III
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ITEM
10.
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DIRECTORS,
EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE.
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52
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ITEM
11.
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EXECUTIVE
COMPENSATION.
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52
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ITEM
12.
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SECURITY
OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED
STOCKHOLDER MATTERS.
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52
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i
ITEM
13.
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CERTAIN
RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR
INDEPENDENCE.
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52
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ITEM
14.
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PRINCIPAL
ACCOUNTING FEES AND SERVICES.
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52
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PART
IV
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ITEM
15.
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EXHIBITS,
FINANCIAL STATEMENT SCHEDULES.
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53
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Signatures
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ii
CAUTIONARY
NOTE REGARDING FORWARD-LOOKING STATEMENTS
The
information contained in this report, including in the documents incorporated by
reference into this report, includes some statements that are not purely
historical and that are “forward-looking statements.” Such forward-looking
statements include, but are not limited to, statements regarding our company’s
and our management’s expectations, hopes, beliefs, intentions or strategies
regarding the future, including our financial condition, and results of
operations. In addition, any statements that refer to projections, forecasts or
other characterizations of future events or circumstances, including any
underlying assumptions, are forward-looking statements. The words “anticipates,”
“believes,” “continue,” “could,” “estimates,” “expects,” “intends,” “may,”
“might,” “plans,” “possible,” “potential,” “predicts,” “projects,” “seeks,”
“should,” “will,” “would” and similar expressions, or the negatives of such
terms, may identify forward-looking statements, but the absence of these words
does not mean that a statement is not forward-looking.
The
forward-looking statements contained in this report are based on current
expectations and beliefs concerning future developments and the potential
effects on the parties and the transaction. There can be no assurance that
future developments actually affecting us will be those anticipated. These
forward-looking statements involve a number of risks, uncertainties (some of
which are beyond the parties’ control) or other assumptions that may cause
actual results or performance to be materially different from those expressed or
implied by these forward-looking statements, including the
following:
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·
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our
reliance on one product for approximately 85% of our
revenues;
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·
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our reliance on limited suppliers
for Sanchi, a scarce plant that is the primary ingredient in almost all of
our products;
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·
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replacement
of our primary product by other medicines or the removal of our primary
product from China’s Insurance
Catalog;
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·
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our ability to raise additional
capital needed for working capital, future operations and research and
development;
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our
ability to collect on advances to sales
representatives;
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our reliance on our three largest
customers for a significant percentage of our
sales;
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our
ability to effectively grow
management;
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our dependence on key
personnel;
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·
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our
ability to establish and maintain a strong
brand;
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·
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the ability of our products to
effectively compete with those of our
competitors;
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·
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continued
receipt and maintenance of regulatory approvals, certificates, permits and
licenses required to conduct business in
China;
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·
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our ability to collect on trade
receivables;
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·
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our
ability to develop and market new products, including those with high
profit margins;
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·
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additional products being subject
to price controls by the Chinese
government;
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·
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protection of our intellectual
property rights;
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·
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loss
of certain tax concessions;
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·
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our lack of insurance to cover
losses due to fire, casualty or
theft;
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·
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changes
in the laws of the PRC that affect our
operations;
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·
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changes in the foreign currency
exchange rate between U.S. dollars and
Renminbi;
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·
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cost
of complying with current and future governmental regulations and the
impact of any changes in the regulations on our
operations;
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·
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the effect on our operations of
costs associated with the Restatement, including litigation
costs;
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·
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a
downturn in the economy of the PRC or inflation in the
PRC;
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1
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·
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our ability to establish and
maintain adequate management, legal and financial controls, including
effective internal controls over financial
reporting;
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volatility
of the market for our common stock;
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·
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the possibility of substantial
sales of our common stock;
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influence
of our principal stockholder;
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·
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cooperation of the minority
shareholder of our principal operating subsidiary;
and
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·
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other factors referenced in this
report, including, without limitation, under the sections entitled “Risk
Factors,” “Management’s Discussion and Analysis or Plan of Operation,” and
“Description of Business.”
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The risks
included above are not exhaustive. Other sections of this report may include
additional factors that could adversely impact our business and operating
results. Moreover, we operate in a very competitive and rapidly changing
environment. New risk factors emerge from time to time and we cannot predict all
such risk factors, nor can we assess the impact of all such risk factors on our
business or the extent to which any factor, or combination of factors, may cause
actual results to differ materially from those contained in any forward looking
statements.
You
should not rely upon forward-looking statements as predictions of future events.
We cannot assure you that the events and circumstances reflected in the
forward-looking statements will be achieved or occur. Although we believe that
the expectations reflected in the forward-looking statements are reasonable, we
cannot guarantee future results, levels of activity, performance or
achievements. Moreover, neither we nor any other person assume responsibility
for the accuracy and completeness of the forward-looking statements. Except as
required by law, we undertake no obligation to update publicly any
forward-looking statements for any reason after the date of this report to
conform these statements to actual results or to changes in our
expectations.
You
should read this report, and the documents that we reference in this report and
have filed as exhibits to this report with the Securities and Exchange
Commission, completely and with the understanding that our actual future
results, levels of activity, performance and achievements may materially differ
from what we expect. We qualify all of our forward-looking statements by these
cautionary statements.
2
PART
I
ITEM
1. BUSINESS.
Unless
the context otherwise requires, the terms “Shenghuo,” the “Company,” “we,” “us,”
or “our” as used throughout this report refer to China Shenghuo Pharmaceutical
Holdings, Inc., our 94.95%-owned subsidiary Kunming Shenghuo Pharmaceuticals
(Group) Co., Ltd. (“Shenghuo China”), and Shenghuo China’s subsidiaries
organized under the laws of the People’s Republic of China (“PRC” or “China”):
Kunming Shenghuo Medicine Co., Ltd. (99% interest), Kunming Pharmaceutical
Importation and Exportation Co., Ltd. (99% interest), Kunming Shenghuo Cosmetics
Co., Ltd. (98.18% interest), Kunming Beisheng Science and Technology Development
Co., Ltd. (70% interest), and Shi Ling Shenghuo Co., Ltd.
(wholly-owned).
Overview
We were
incorporated in the State of Delaware on May 24, 2005. We are primarily engaged
in the research, development, manufacture, and marketing of pharmaceutical,
nutritional supplement and cosmetic products. Almost all of our products are
derived from the medicinal herb Panax notoginseng, also known as Sanqi, Sanchi
or Tienchi. Panax notoginseng is a greyish-brown or greyish-yellow plant that
only grows in a few geographic locations on Earth, one of which is Yunnan
Province in southwest China, where our operations are located. The main root of
Panax notoginseng is cylindrically shaped and is most commonly one-to-six
centimeters long and one-to-four centimeters in diameter. Panax notoginseng
saponins (PNS), the active ingredient in Panax notoginseng, is extracted from
the plant using high-tech equipment and in accord with Good Manufacturing
Practice (GMP) standards. Our main product, Xuesaitong Soft Capsules, accounted
for approximately 85% of our sales for the year ended December 31,
2009.
Market
Focus
Since our
founding, we have focused primarily on the development of products to serve
three major markets—cardiovascular and cerebrovascular disease, peptic ulcer
disease and health products. Our goal has been to focus on the development of
pharmaceutical products and over-the-counter products based on traditional
Chinese medicines designed to address these areas.
·
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Cardiovascular
and Cerebrovascular Disease. Hyperlipemia, which
is high circulating blood levels of fats such as cholesterol and
triglycerides, has ranked high on the list of modern health diseases. The
primary effect of hyperlipemia is the development of cardiovascular and
cerebrovascular diseases, including heart attacks and
strokes.
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·
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Peptic
Ulcer Disease. A peptic ulcer is an
erosion of the lining of the stomach or the upper part of the small
intestine. The causative factors may include excess stomach acid, excess
pepsin, Helicobacter Pylori infection, poor health and eating habits, and
psychological stress. There is no radical cure for peptic ulcers, which
may eventually lead to gastric hemorrhage, gastric perforation and even
cancer. People of all ages can be affected by peptic ulcers, but they are
most prevalent in persons between the ages of 45 and 55, with incidences
in men being slightly higher than in
women.
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·
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Health
and Food Products. The health products
industry, which consists of non-prescription traditional Chinese medicines
and supplements, has grown as a result of quality improvements in products
and the introduction of new products to the market in China. Over the past
two decades, health product sales in Chinese urban areas have increased.
The Chinese Ministry of Health has approved several uses for health
products and a substantial number of the products on the market are
designed to aid in immunoregulation, blood fat regulation and fatigue
resistance. In addition, China’s market for cosmetics products is one of
the largest in Asia and within the top ten in the
world.
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3
Products
We are
primarily engaged in the research, development, manufacture, and marketing of
pharmaceutical, nutritional supplement and cosmetic products. Almost all of our
products are derived from the medicinal herb Panax notoginseng, also known as
Sanqi, Sanchi or Tienchi. Panax notoginseng is a greyish-brown or greyish-yellow
plant that only grows in a few geographic locations on Earth, one of which is
Yunnan Province in southwest China, where our operations are located. The main
root of Panax notoginseng is cylindrically shaped and is most commonly
one-to-six centimeters long and one-to-four centimeters in diameter. Panax
notoginseng saponins (PNS), the active ingredient in Panax notoginseng, is
extracted from the plant using high-tech equipment and in accord with Good
Manufacturing Practice (GMP) standards. Our three major suppliers of Sanchi
plant are Wenshan Jian Yuan Traditional Chinese Medicine Materials Trade Co.,
Ltd., the Wenshan County Yatai Agricultural and Sideline Products Trade Co.,
Ltd. and the Wenshan Innovation Centre of Sanchi Science and Technology Co.
Ltd.
Pharmaceutical
Products
Our
pharmaceutical product, the Xuesaitong Soft Capsule, is marketed under the
Lixuwang brand name and other products are marketed under the Shenghuo brand
name, which has been granted Famous Trademark status in Yunnan Province. Famous
Trademark is granted by the Administration of Industry and Commerce of Yunnan
Province after being approved by the Provincial Brand Attestation Council. This
trademark indicates that the Company and its products have the support of the
provincial government of Yunnan Province as a provincial leading enterprise and
its product has a strong reputation in quality, after-sale services and market
sales. The following is a list of our approved pharmaceutical
products and their intended uses:
Product Name
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Intended Use
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|
Xuesaitong
Soft Capsules
|
Designed
to invigorate the circulation of blood and improve microcirculation. Used
for the treatment of symptoms of cardiovascular and cerebrovascular
disease, such as angina pectoris, strangulation, squeezing and crushing of
chest, acute and chronic peripheral vascular-metabolic disorders, brain
occlusion, occlusion of retina central vein, acute and chronic cerebral
vascular-metabolic disorders caused by arteriosclerosis. This product
accounted for approximately 85% of our sales for the year ended December
31, 2009.
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Qiye
Shen’an Tablets
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Designed
to help relieve headache, insomnia, and palpitation. Designed to
invigorate the circulation of blood, improve microcirculation and improve
liver functionality.
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Banlangen
Tablets
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Designed
for the treatment of parotitis, pharyngitis, mastitis, swollen and sore
throat due to cold and influenza.
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Bergenini
Tablets
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Designed
to help relieve cough and phlegm due to bronchial
ailments.
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Huangtengsu
Tablets (film tablets)
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Designed
to treat the symptoms of dysentery, enteritis, respiratory tract
infections, uncomplicated urethral, surgery infections and
conjunctivitis.
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Danshen
Tablets
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Designed
to regulate blood circulation and treat the symptoms of blood stasis.
Designed to treat the symptoms of coronary arteriosclerosis, angina
pectoris and hyperlipemia.
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Triperygium
hypoglaucum Hutch Tablets
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An
immunosuppressant designed to treat the symptoms of rheumatoid
arthritis.
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Huangtengsu
Soft Capsules
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Designed
to treat symptoms of dysentery, enteritis, respiratory tract infections,
surgery infections and conjunctivitis.
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Tian
Xin Soft Capsules (formerly known as Li Xu Wang Shu Tong Soft
Capsules)
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Designed
to reduce blood viscosity and improve blood
circulation.
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4
Product Name
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Intended Use
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Radix
Polygoni Multiflori Capsules
|
Designed
to treat effects of weakness of the kidney and liver, fatigue, and
dizziness due to blood
deficiencies.
|
We have
the following additional drugs that are currently in Phase II clinical trials
for prescription use:
·
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Wei Dingkang
Soft Capsules are a
type of traditional Chinese medicine designed to treat peptic ulcer
disease by inhibiting bacterial growth, relieving stomach muscle spasms,
and reducing inflammation of the intestinal lining. The product is
designed to be effective for upset stomach, vomiting, pain and degradation
of the stomach lining. The product has been approved by the State Food and
Drug Administration (SFDA) for clinical testing. Phase II clinical trials
were completed in December 2007. Phase II exploratory and
enhanced clinical trials have commenced and are expected to be completed
by August 2010, after which Phase III will start. We anticipate obtaining
production approval by the end of
2012.
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·
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Dencichine
Hemostat is designed
to be a non-toxic product that addresses a range of anti-hemorrhagic
applications, such as stopping bleeding without causing clotting. We
anticipate receiving governmental approval for the production and
marketing of the product in 2011. Assuming required governmental approvals
are obtained in a timely fashion, we anticipate that production and
marketing of the product will begin no sooner than 2012. Dencichine
Hemostat is a drug requiring extensive testing by the national SFDA,
including neurotoxicity testing, which may take a significant amount of
time. In addition, clinical testing and audit processes are out of our
control, so we must allow for additional
time.
|
Health
and Food Products
We offer
a wide array of over-the-counter supplements as well as vitamin capsules and
pills. The following are some of our non-prescription products and their
intended uses. We have received government approval and currently market each of
the supplements listed below.
Product Name
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Intended Use
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Banlangen
Grains
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Health
product designed to treat swollen and sore throat due to cold and
influenza.
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Gegenqinlian
Tablets
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Health
product designed to reduce stomach discomfort and treat
diarrhea.
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Huangtensu
Soft Capsules
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Designed
to treat symptoms of dysentery, enteritis, respiratory tract infections,
surgery infections and conjunctivitis.
|
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Luotongding
Tablets
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Health
product designed to reduce visceral pain, headache, and
cramping.
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Paracetamol
Caffeine and Aspirin Powders
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Health
product designed to treat headaches, migraines and fevers caused by
influenza and cold.
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Siji
Sanhuang Tablets
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Health
product designed to relieve inflammation and alleviate fever, commonly in
connection with pharyngitis.
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Sulfadiazine
Silver Ointment
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Health
product designed to assist in the prevention of infections related to
burns.
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Tianqi
Tongjing Capsules
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Health
product designed to treat dysmenorrhea and emmeniopathy caused by
colds.
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Vitamin
AD Soft Capsules
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Health
product designed to treat deficiencies of Vitamin A and
D.
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Vitamin
C Tablets
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Health
product designed to treat deficiencies of Vitamin
C.
|
5
Product Name
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Intended Use
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Vitamin
B6 Tablets
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Health
product designed to treat deficiencies of Vitamin B6.
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Vitamin
E Soft Capsules
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Health
product designed to treat deficiencies of Vitamin E.
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Yinhuang
Capsules
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Health
product designed to relieve inflammation and sore of
throat.
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Lycopene
Soft Capsules
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Food
product designed to treat side effects of and act as a general deterrent
to certain carcinogens.
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Oil
of Purple Perilla Soft Capsules
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Food
product designed to treat effects of cough, asthma and
astriction.
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Rhizoma
Aspidii and Chinese Wampi leaf Grains
|
Designed
to treat effects of fever, aversion, headache, cough with excessive
sputum.
|
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Soya
Lecithin Soft Capsules
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Food
product designed to treat effects of high blood fat, hypertension and
other diseases of cardiovascular and cerebrovascular
systems.
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Spirulina
Soft Capsules
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Food
product designed to normalize stomach and intestinal
functions.
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Tian
Xin Soft Capsules
|
Designed
to reduce blood viscosity and improve blood
circulation.
|
|
Radix
Polygoni Multiflori Capsules
|
Designed
to treat effects of weakness of the kidney and liver, fatigue, and
dizziness due to blood
deficiencies.
|
The SFDA
issues certificates of medicine production approval that include the names,
specifications, approval numbers and other information about the approved
medicines. According to the law of the Drug Administration of the People’s
Republic of China, a drug-manufacturing factory must acquire both the
certificate of medicine production permit and medicine production approval
before the drug-manufacturing factory has the necessary qualifications to
manufacture, market and sell the medicine.
Our
anticipated timelines for introduction and marketing of our new drugs depend, in
large part, on government approval as well as our experience in the approval
process and our communications with the SFDA. Therefore, there is no assurance
that such approvals will be obtained at all, or that the anticipated timelines
will be met. For instance, we intended to introduce and market certain generic
non-prescription supplements such as Fructus Ligustri Lucidi, Radix Astragali
Soft Capsules, Ginseng and Pilose Antler Soft Capsules, and Tranquilization Soft
Capsules and had applied for approvals that were anticipated to be obtained
during 2008. However, in July 2007, China’s former drug and food safety watchdog
chief, Xiaoyu Zheng, was executed after being found guilty of corruption and
dereliction of duty. Mr. Zheng’s failure to maintain proper standards and carry
out correct pharmaceutical safety inspections led to approval of many medicines
that should have been blocked or taken from the market. In order to cure Mr.
Zhang’s dereliction, SFDA adapted a series of measures to tighten safety
controls and strengthen its safety procedures for the pharmaceutical approval
process. For these reasons, many drugs that had applications pending were forced
to carry out re-examination and approvals have been delayed. In
response to this changed regulatory process, the Company determined not to
pursue its applications on proposed products further, and instead to shift
research and development efforts from making generic drugs to high-tech ones
like Wei Dingkang Soft
Capsules as well as
Dencichine Hemostat.
Cosmetic
Products
We also
offer an expanding line of cosmetic products including lotions, creams and other
cosmetic items. We have conducted extensive research and have specifically
formulated our cosmetic products to meet the cosmetic and skincare needs of our
female consumers. Our “12 Ways™ Chinese Traditional Medicine Beauty Salon
Series” (“12 Ways”) is a line of over 100 cosmetic products that includes facial
masks and creams, skin and eye creams, and shampoos. Our line of products has
acquired production approval to be sold only in China. Each of our cosmetic
skincare products contains natural ingredients including herbal anti-irritants
and anti-oxidants, as well as Sanchi. Our comprehensive line of skincare
includes a mixture of basic products (e.g., creams and gels), treatment products
(e.g., firming treatments), specialty helpers (e.g., masks), and beauty
supplements. The use of supplements is an important element of skincare,
nurturing the skin’s health using vital nutrients. Our cosmetic line combines
the strength of several skincare methods to achieve healthy skin and
beauty.
6
We have
expanded the geographic region in which our 12 Ways products were sold from our
native Yunnan province to a number of cities and provinces outside our local
region. We have opened a number of retail specialty counters to offer our
cosmetic products at pharmacies throughout Eastern China, and we hope to
eventually expand our retail presence across China. As of December 31, 2009, we
have opened approximately 618 retail specialty counters in more than 30 cities
throughout China, including main cities such as Beijing, Nanjing, Hangzhou,
Suzhou, Jinan, Weifang Shengzhen and Zhengzhou, and most of provinces in China
such as Hubei, Shanxi, Yunnan, Shandong, and Anhui. In addition, we
opened a 12 Ways Chinese Herbal Beauty Salon in Kunming that will feature
approximately ten traditional Chinese medicine practitioners and beauticians
that provide a variety of services, including acupuncture, body massage, foot
massage and other services. All products used in the salon will be supplied by
us. Management hopes that the opening of this salon and the opening of retail
counters will allow us to increase our brand recognition and strengthen
marketing. Our ability to effectively open and operate new retail locations
depends on several factors, including, among others, our ability to identify
suitable counter locations, the availability of which is outside our control;
our ability to prepare counters for opening within budget; our ability to hire,
train and retain personnel; our ability to secure required governmental permits
and approvals; our ability to contain payroll costs; and our ability to generate
sufficient operating cash flows or secure adequate capital on commercially
reasonable terms to fund short term cash needs and our expansion
plans.
Our line
of cosmetic products includes the following food products and health
supplements.
Product Name
|
Intended Use
|
|
Jasmine
Tea
|
Food
product designed to help and promote healthy skin affected by
acne.
|
|
Rose
Tea
|
Food
product designed to help promote healthy skin and
complexion.
|
|
SHEN
HUO Beauty Soft Capsules
|
Health
supplement designed to help with balancing water in the
body.
|
|
SHEN
HUO Brighten Soft Capsules
|
Health
supplement designed to help promote healthy skin affected by
spotting.
|
|
SHEN
HUO Immaculacy Soft Capsules
|
Health
supplement designed to help promote healthy skin affected by
acne.
|
|
12
Ways Yunnan Bamboo Anti-Acne Cream
|
Health
supplement designed to help promote healthy skin affected by
acne.
|
|
12
Ways DanShen Spot Fade Light Cream
|
Health
supplement designed to lighten skin discoloration.
|
|
12
Ways Eye care series
|
Health
supplement designed to improve the appearance of fine lines, dark circle,
and puffiness.
|
|
12
Ways Sunscreen Series
|
Sunscreen
product.
|
|
12
Ways Panax Notoginseng Moisturizer Series
|
Moisturizer.
|
|
12
Ways Snow Poria Whiten Series
|
Health
supplement designed to lighten and whiten the
skin.
|
7
Growth
Strategies
We
believe that our business has opportunities for growth through the following
growth strategies:
|
·
|
New
Product Development. We have traditionally focused on
research and development of products serving the cardiovascular and
cerebrovascular disease, peptic ulcer disease and health products markets.
We intend to devote additional resources to research and development and
to continue to evaluate and develop high-tech and efficient Traditional
Chinese Medicine (“TCM”), where we perceive an unmet need and commercial
potential, and to improve existing products to enhance their
efficacy.
|
|
·
|
Focus
on Brand Development. With intense price competition
among many similar or identical products in the industry, we believe that
building brand equity is the primary means to generate and sustain
profitable growth in the future. Our brand strategy is centered on
“Lixuwang”—the brand under which most of our products are sold. We believe
that our relationships within the Chinese pharmaceutical industry are key
to building brand equity, which we can benefit from by developing and
maintaining relationships with professionals within the industry,
especially with physicians and
hospitals.
|
|
·
|
Domestic
Growth (China). We
intend to grow our internal marketing and sales function and increase our
relationships with potential customers to expand the distribution and
presence of our non-prescription brands and cosmetics. In expanding market
share of our products, we intend to take advantage of our large
manufacturing scale and reasonable cost control mechanisms, and our strong
sales network. In addition, our goal is to establish our products as a
preferred choice for prescription drugs in major hospitals. We believe
that establishing a strong reputation with major hospitals may open the
market for smaller, community and rural hospitals because patients from
large hospitals also receive services from smaller
hospitals. We hope to add other prescription drugs, some of
which are now in late-stage clinical trial, into this channel over the
next few years.
|
|
·
|
International
Growth. In addition
to China, we have sold our products in Asian countries such as Indonesia,
Singapore, Japan, Malaysia, Thailand and European countries such as the
United Kingdom, Tajikistan, Russia and Kyrgystan. We hope to expand sales
into other countries where our products could be affordable treatment
options.
|
|
·
|
Growth
of Cosmetics Market Share. We intend to focus on the
expansion of our cosmetics product line and devote additional marketing
and sales resources. We hope that our cosmetics products will account for
a larger percentage of our revenue in the
future.
|
In 2009,
we developed the following four strategies to stabilize and further expand
the market for our products: (1) attracting further investment, especially
for provinces with low coverage, by implementing a policy of inviting
investment, enhancing sales team construction as well as professional training
and marketing promotion; (2) developing a plan and budget to expand distribution
into the hospitals, which are not selling our products; (3) widening commercial
channels by focusing on (i) strengthening the assessment of sales
representative/agent’s commercial credits and accounts receivable
management, (ii) integrating the resources of commercial channels on the
basis of market conditions, and (iii) taking advantage of commercial
channels to promote terminal distribution; and (4) expanding the over the
counter market, based on the reputation of Lixuwang Soft Capsules, by
launching over the counter products to the market, increasing market
shares and sales scope and maximizing profit.
Research
and Development
As of
December 31, 2009, we employed 61 technicians, including 17 senior researchers,
23 mid-level researchers, and 21 junior analysts. The technicians’
specializations include medicine, pharmacology, chemistry, biology, and medicine
production equipment. The amount spent for the
years ended 2009 and 2008 on research and development is $139,944 and $338,546
respectively.
8
In an
attempt to capitalize on the natural resource of Sanchi in Yunnan Province and
to develop a strong medical industry in the Yunnan Province, we established an
enterprise technology center – Kunming Beisheng Science and Technology
Development Company – in cooperation with the Shijia Research Center of Beijing
University. However, the project has not generated revenues or conducted
operations and the Company is applying for the approval from the government to
dissolve Kunming Beisheng Science and Technology Development
Company. Accordingly, the Company has established its own Technology
Center, which has been equipped with advanced instruments and has recruited
highly educated and experienced senior technicians to carry on the projects
intended for the Shijia Research Center, such as developing new techniques of
extraction, purification and quality control. Moreover the objectives of our
Technology Center are the same as we set with Shijia: modernizing Chinese
medicine development techniques; improving technological skill and processing
techniques; industrialization of Chinese herbal medicine; creation of
intellectual property rights; and deepening research into high-end Yunnan
Province medicine. The business scope of the project includes development and
technology transfer of bulk pharmaceuticals, prepared Chinese medicine,
chemicals, biologicals, health food, and medical cosmetic products; importation
of scientific instruments and medical technology, and communication with foreign
and domestic research centers.
Establishing
the Company owned Technology Center has greatly enhanced the Company’s research
and development efforts by encouraging independent innovation, strengthening
independent research and development capacity and boosting international
competitiveness and reducing research and development expenses.
Marketing
and Sales
As of
December 31, 2009, our marketing team maintains sales offices in approximately
31 provinces throughout China. The sales network covers approximately 210 cities
and is staffed by approximately 612 sales representatives.
Our main
customers are regional wholesale companies, who resell our products to local
hospitals, drug stores, and other channel distributors. In addition, we sell our
products directly to retail drug stores. Our three largest customers accounted
for approximately 19.8%, 19.4%, and 32.1% of our sales for the years ended
December 31, 2009, 2008, and 2007, respectively.
Prices
for our products are fixed and determinable. Each time products are purchased, a
specific price is agreed upon, a contract is signed and we and the customer are
legally bound and neither can change the price. Prices for products are normally
derived from our standard price lists; however, larger, more established
customers are given quantity discounts. There are no instances in which payment
for products sold is contingent on re-sell to or otherwise used by end-user
patients.
We have
established sales offices in many cities in China that manage sales
representatives according to our internal management rules and sales policy.
Because the main product “Xuesaitong” capsule is sold to hospitals through
regional wholesale companies located in the various cities of China and because
China has thousands of wholesale companies, we employ a large number of sales
representatives to expand into new markets and gain new customers.
Sales
representatives will be provided with certain sales targets for a particular
period according to set price. The sales representatives who complete the sales
task within the prescribed period, will be given greater economic incentives and
future cooperation opportunities. According to our sales policy, sales
representatives earn commissions from us based on the sale amount and the amount
collected. The Company reimburses the sales representatives their selling and
marketing expenses when they submit the appropriate documentation to be
reimbursed and their sales are collected. The Company reimburses the sales
representatives their accrued selling expenses when the related accounts
receivable are collected.
We
started to expand our business into the OTC market in selected areas around
China during 2009. For example, the gross sales of Lixuwang in the
OTC market in Yunnan province amounted to RMB 6 million, resulting in a profit
realized by the Company of about RMB 2 million. Based on these positive results,
we will continue to expand our presence in the OTC market in 2010 in provinces
such as Jiangsu, Fujian, Guangdong and Zhejiang. The Company reimburses the
sales representatives their accrued selling expenses when related accounts
receivable are collected.
9
Production
We
manufacture and package our products at our factory located in Kunming, China.
The factory, which was built in 2000, is approximately 161,460 square feet and
includes a clean area that occupies approximately 86,110 square feet. Our clean
area in the production facilities includes approximately 52,500 square feet of
Class 10,000 certified area and 2,350 square feet of Class 100,000 certified
area. The cleanliness classification is based on the number of dust particles
and bacteria per cubic meter, so lower numbers indicate a higher cleanliness
class. According to the Regulation for Quality Control of Drug Production issued
by the SFDA, oral preparations of traditional Chinese medicines must be produced
in a Class 300,000 certified or lower area. Our production facilities use
equipment imported from the U.S. and are designed to meet American standards, so
our Class 10,000 and Class 100,000 certified areas are cleaner than the Chinese
national standard. The production facilities have more than 600 machines and
supporting parts for pharmaceutical production from domestic and foreign
suppliers. The factory has a total of 28 complete production lines for
semi-finished and finished hard capsules, tablets, granules, powder, electuary,
and emulsifier. The key facilities are two soft capsule production lines
obtained from GIC Company, an American producer of industrial machinery,
and an automatic packaging production line purchased from Klockner Haensel GmbH,
a German company. In addition, all of our precision testing machines are
supplied by Sharp Document Systems, U.S.A. Our production facilities were
certified to be in compliance with Good Manufacturing Practice (GMP) standards.
Our GMP certifications are renewed through July 18, 2012, for the production of
health food products and supplements, including soft capsules, hard capsules,
tablets and granule productions. We also received an additional GMP
certification for production of pharmaceutical ointment products.
We
utilize a complex process in extracting active components from the Sanchi plant,
purifying the components and manufacturing our products. A typical manufacturing
process begins by obtaining the Sanchi plant from our supplier, washing, and
dividing it into main root, branch root and rhizome. The branch root known as
“Sanchi Jintiao” and rhizome is known as “Sanchi Jiankou.” The Sanchi Jiankou is
the portion of the Sanchi that contains the active ingredient, Panax Notoginseng
Saponins. The Sanchi Jiankou is then sent through a heavy pulverizing machinery
to crush it into a specified powder size. The Sanchi Jiankou powder then
undergoes a complex extracting process in which the powder is mixed with
extracting solvents and the resulting solution is percolated and filter
processed. The solution is concentrated by vacuum equipment while the extracting
solvent is recollected and the active ingredient condensate is collected. The
active ingredient condensate is then separated and purified through a
chromatographic column, and the Sanchi polysaccharides and Sanchi saponins are
collected separately. The solutions of Sanchi saponins and Sanchi
polysaccharides are then separately purified by a second chromatographic column
to remove pigments and other useless compounds and obtain the pure saponins and
polysaccharides, respectively. The Sanchi saponins and Sanchi polysaccharides
are then separately dried by a spray-dryer. The resulting powders are
weighed and packaged into separate contamination resistant plastic bags, which
undergo quality control inspections and are stored in a warehouse for use in our
line of products. Production of each product varies depending on the ingredients
and form of the product. Production usually includes mixing of the
Sanchi powder and the delivery agent, such as oil for soft
capsules. The ingredients are then processed using advanced pressing,
drying, polishing and blister packaging equipment.
Quality
Control
Our
production facilities are designed and maintained with a view towards conforming
with good practice standards. To comply with GMP operational requirements, we
have implemented a quality assurance plan setting forth our quality assurance
procedures. Our Quality Control department is responsible for maintaining
quality standards throughout the production process. Quality Control executes
the following functions:
|
·
|
setting internal controls and
regulations for semi-finished and finished
products;
|
|
·
|
implementing sampling systems and
sample files;
|
|
·
|
maintaining the quality of
equipment, instruments, reagents, test solutions, volumetric solutions,
culture media and laboratory
animals;
|
|
·
|
auditing production records to
ensure delivery of quality
products;
|
|
·
|
monitoring the number of dust
particles and microbes in the clean
areas;
|
10
|
·
|
evaluating stability of raw
materials, semi-finished products and finished products in order to
generate accurate statistics on storage duration and shelf
life;
|
|
·
|
articulating the responsibilities
of Quality Control staff;
and
|
|
·
|
on-site evaluation of supplier
quality control systems.
|
Competition
The
pharmaceutical industry both within China and globally is increasingly
competitive and is characterized by rapid and significant technological
progress. Our competitors, both domestic and international, include large
pharmaceutical companies, universities, and public and private research
institutions that currently engage in or may engage in efforts related to the
discovery and development of new pharmaceuticals. Many of these entities have
substantially greater research and development capabilities and financial,
scientific, manufacturing, marketing and sales resources than we do, as well as
more experience in research and development, clinical trials, regulatory
matters, manufacturing, marketing and sales.
Competition
in the manufacture and sale of medical products for cardiovascular and
cerebrovascular disease in China is also intense. There are a large number of
companies that are licensed to manufacture and sell these type of medical
products in China. Western drugs such as lovastatins and nitroglycerine have
more than half of the market share of medications used to treat cardiovascular
and cerebrovascular disease in China. Chinese traditional medicines make up
the next largest part of the market. On the whole, Chinese patent medicine still
generally has many problems such as complex and unclear ingredients,
inconsistent quality, slow action and ineffectiveness. As a result, new Chinese
medicines tend not to stay on the market for very long.
There are
also many Chinese traditional medicines available to treat peptic ulcers. While
they are inexpensive and readily available, they are not as effective as western
medicines. In China, peptic ulcers are usually treated with western medicines
such as H2 blockers (e.g., Zantac), proton pump inhibitors (e.g., Nexium) and
bismuth (e.g., Pepto-Bismol). In addition, amoxicillin and other antibiotics are
now commonly used in conjunction to treat peptic ulcers.
The
market for health and cosmetic products in China is also highly competitive.
Both industries have a high number of competitors, some of which overlap, and
many of which have a longer operating history and higher visibility, name
recognition and financial resources than we do. Our competitors include
manufacturers and marketers of personal care and nutritional products,
pharmaceutical companies and other organizations.
Intellectual
Property
We rely
on a combination of trademark, copyright and trade secret protection laws in
China, as well as confidentiality procedures and contractual provisions to
protect our intellectual property. Our primary product, Xue Saitong Soft
Capsules, first received patent protection and production and new medicine
certification in 1999 which will continue until April 25, 2012. We also have
protections for our technology methods of using Sanchi to help stop bleeding and
combination methods, production and function of the medicine to treat intestinal
disease. Xue Saitong Soft Capsules receive protections from the SFDA, which will
not issue additional drug permits other than those already issued during the
protection period. We have ten registered trademarks in China. Other than the
foregoing, we do not have any measures to prevent any infringement of our
intellectual property rights.
Seasonality
Sales in
the first quarter are usually lower due to people traveling and taking vacations
during the traditional Chinese New Year and Chinese Spring Festival holidays.
Sales in the fourth quarter are usually higher.
11
Government
Regulations of Pharmaceuticals
Testing,
approval, manufacturing, labeling, advertising, marketing, post-approval safety
reporting, and export of our products or product candidates are extensively
regulated by governmental authorities in the PRC and other countries. Our
principal sales market is presently in China. We are subject to the Drug
Administration Law of China, which governs the licensing, manufacturing,
marketing and distribution of pharmaceutical products in China and sets
penalties for violations. Additionally, we are subject to various regulations
and permit systems by the Chinese government.
The
application and approval procedure in China for a newly developed drug product
has numerous steps. New drug applicants prepare the documentation of
pharmacological study, toxicity study and pharmacokinetics and drug metabolism
(PKDM) study and new drug samples. Documentation and samples are then submitted
to provincial food and drug administration (“provincial FDA”). The provincial
FDA sends its officials to the applicant to check the applicant’s research and
development facilities and to arrange a new drug examination committee meeting
for approval deliberations. This process usually takes three months. After
documentation and sample approval, the provincial FDA will submit the approved
documentation and samples to SFDA. SFDA examines the documentation and tests the
samples and arranges a new drug examination committee meeting for approval
deliberations. If the application is approved by SFDA, SFDA will issue a
clinical trial license to the applicant for clinical trials. The clinical trial
license approval typically takes one year. The applicant completes the clinical
trial process and prepares documentation and files for submission to SFDA for
new drug approval. The clinical trial process usually takes one to two years,
depending on the category and class of the new drug. SFDA examines the
documentation, gives final approval for the new drug, and issues the new drug
license to the applicant. This process usually takes eight months. The whole
process for new drug approval usually takes three to four years.
Insurance
Catalogues
Pursuant
to the Decision of the State Council on the Establishment of the State Basic
Medical Insurance System for Urban Employees and the Implementation Measures for
the Administration of the Scope of Medical Insurance Coverage for
Pharmaceuticals for Urban Employees, the Ministry of Labor and Social Security
in China established the State Insurance Catalogue. The State Insurance
Catalogue is divided into Parts A and B. The medicines included in Part A are
designated by the Chinese governmental authorities for general application.
Local governmental authorities may not adjust the content of medicines in Part
A. Although the medicines included in Part B are designated by Chinese
governmental authorities in the first instance, provincial level authorities may
make limited changes to the medicines included in Part B, resulting in some
regional variations in the medicines included in Part B from region to region.
Patients purchasing medicines included in Part A are entitled to reimbursement
of 100% of the costs of such medicines from the social medical fund in
accordance with relevant regulations in China. Patients purchasing medicines
included in Part B are required to pay a predetermined proportion of the costs
of such medicines (approximately 10% of such costs).
The
medicines included in the Insurance Catalogues are selected by the Chinese
government authorities based on various factors including treatment
requirements, frequency of use, effectiveness and price. Medicines included in
the Insurance Catalogue are subject to price control by the Chinese government.
The Insurance Catalogues are supposed to be revised every two years. In
connection with each revision, the relevant provincial drug authority collects
proposals from relevant enterprises before organizing a comprehensive appraisal.
The Ministry of Labor and Social Security then makes the final decision on any
revisions based on the preliminary opinion suggested by the provincial drug
administration. Other than completing a normal application process, we have no
role in the selection of products for inclusion in the Insurance
Catalog.
In
addition to the State Insurance Catalogue, each of the 31 Chinese provinces
establishes its own provincial insurance catalogues (each, a
“PIC”). A drug listed on the PIC will result in the patient
purchasing such drug to receive the same 90% reimbursement as if such drug were
listed on Part B of the State Insurance Catalogue.
Since
2005, our primary product, Xuesaitong Soft Capsules has been listed in Part B of
the State Insurance Catalogue. Xuesaitong Soft Capsules represented
approximately 85% of our sales for the year ended December 31,
2009. In November 2009, the Ministry of Labor and Social Security in
China announced the updated State Insurance Catalogue, which takes effect on
July 1, 2010, and the Xuesaitong Soft Capsules will no longer be
listed. Therefore, until the effective date of the updated State
Insurance Catalogue, the Xuesaitong Soft Capsules will remain in Part B of the
State Insurance Catalogue. We are seeking to have other products
listed in the State Insurance Catalogue. At present, it has been
announced that Banlangen Tables, Dansheng Tables and Sulfadiazine Silver
Ointment have already been approved to be listed in the newly announced State
Insurance Catalogue. The Ministry of Labor and Social Security in
China plans to update the State Insurance Catalogue every two years, but since
2000, the catalog has been updated only twice.
12
In order
to mitigate the negative impact the removal from the State Insurance Catalogue
may have on the Company, we have been coordinating with various provinces to
list the Xuesaitong Soft Capsules on the various PICs and our communications
with various provinces are great. It is expected that the
various provinces will make a decision on their individual listings by May 30,
2010.
Further,
the Department of Heath in China, which makes an independent assessment of the
drugs available, publishes an “essential drug list” as to what drugs are basic
and prevalent and can satisfy the ordinary need for drugs to all the people. If
a drug is listed on the “essential drug list,” it is automatically included in
Part A of the State Insurance Catalogue. The Company’s Xuesaitong
Soft Capsules were listed on the “essential drug list” in 2000 and 2004 and the
Company is attempting to have the drug relisted on that list in 2010 to mitigate
and even improve its position with respect to drug reimbursement for
patients.
Price
Controls
Drugs
that are listed in the State Insurance Catalogue and whose production or trading
will constitute monopolies are commonly subject to price control by the Chinese
government. The maximum prices of such medicine products are published by the
state and provincial administration authorities from time to time. The prices of
other medicines that are not subject to price control are determined by the
pharmaceutical manufacturers, subject, in certain cases, to providing notice to
the provincial pricing authorities. Since 2005, our primary product, Xuesaitong
Soft Capsules, is subject to retail and wholesale price controls.
The price
of Xuesaitong Soft Capsules is mainly determined by our company and will no
longer be subject to price control by The National Development and Reform
Commission of the PRC after July 1, 2010 due to the removal from the State
Insurance Catalogue. But the price is to be reported to the provincial pricing
authorities where our Xuesaitong Soft Capsules is listed in their PICs. The
original price, as approved by the government, was 45 RMB (U.S. $5.63) per box
of 24 capsules. As of December 31, 2009, its maximum price has been adjusted to
44.2 RMB (U.S. $5.53) per box of 24 capsules. Our application to The National
Development and Reform Commission (The “NDRC”) of the PRC requesting that the
Xuesaitong Soft Capsules be placed into the category of “Higher Price for Better
Quality” was approved in March 2007. Therefore, the drug benefits from price
protection and is exempted from price reduction. Moreover, the category has
become a standard of choosing medicines for cardiovascular and cerebrovascular
disease.
Environmental
Matters
We comply
with the Environmental Protection Law of China as well as the applicable local
regulations. In addition to statutory and regulatory compliance, we actively
ensure the environmental sustainability of our operations. Penalties would be
levied upon us if we fail to adhere to and maintain certain standards. Such
failure has not occurred in the past, and we generally do not anticipate that it
will occur in the future, but no assurance can be given in this
regard.
Employees
As of
December 31, 2009, we had 556 full-time, salaried employees and 433 of these
employees receive labor insurance. These employees are organized into a union
under the labor laws of China and can bargain collectively with us. In addition,
we employ over 600 sales representatives who are paid on a commission basis.
These representatives are not part of the union. We maintain good relations with
our employees.
We are
required to contribute a portion of our employees’ total salaries to the Chinese
government’s social insurance funds, including medical insurance, unemployment
insurance and job injuries insurance, and a housing assistance fund, in
accordance with relevant regulations. We expect the amount of our contribution
to the government’s social insurance funds to increase in the future as we
expand our workforce and operations.
13
Additional
Information
We are
subject to the information and periodic reporting requirements of the Securities
Exchange Act of 1934, as amended (the “Exchange Act”) and in accordance with the
Exchange Act, we file annual, quarterly and special reports, and other
information with the Securities and Exchange Commission. These periodic reports
and other information are available for inspection and copying at the regional
offices, public reference facilities and website of the Securities and Exchange
Commission referred to below.
Statements
contained in this report about the contents of any contract or any other
document that is filed as an exhibit are not necessarily complete, and we refer
you to the full text of the contract or other document filed as an exhibit. A
copy of annual, quarterly and special reports and related exhibits and schedules
may be inspected without charge at the Public Reference Room maintained by the
Securities and Exchange Commission at 100 F Street, N.E., Washington, D.C.
20549. Copies of such reports may be obtained from the Securities and
Exchange Commission upon payment of the prescribed fee. Information regarding
the operation of the Public Reference Room may be obtained by calling the
Securities and Exchange Commission at 1-800-SEC-0330 or visiting their website
at www.sec.gov. The Securities and Exchange Commission maintains a web site that
contains reports, proxy and information statements, and other information
regarding registrants that file electronically with the SEC.
14
ITEM
1A. RISK FACTORS.
Any
investment in our common stock involves a high degree of risk. Investors should
carefully consider the risks described below and all of the information
contained in this report before deciding whether to purchase our common stock.
Our business, financial condition or results of operations could be materially
adversely affected by these risks if any of them actually occur. The trading
price of our common stock could decline due to any of these risks, and an
investor may lose all or part of his investment. Some of these factors have
affected our financial condition and operating results in the past or are
currently affecting our company. This report also contains forward-looking
statements that involve risks and uncertainties. Our actual results could differ
materially from those anticipated in these forward-looking statements as a
result of certain factors, including the risks we face as described below and
elsewhere in this report. With respect to this discussion, the terms “Shenghuo,”
the “Company,” “we,” “us,” or “our” refer to China Shenghuo Pharmaceutical
Holdings, Inc., our 94.95%-owned subsidiary Kunming Shenghuo Pharmaceutical
(Group) Co., Ltd. (“Shenghuo China”) and the five foreign owned subsidiaries of
Shenghuo China that are organized under the laws of the People’s Republic of
China (“PRC” or “China”).
RISKS
RELATED TO OUR OPERATIONS
We
May Not Be Able To Refinance or Repay Loans We Have Received.
As of
December 31, 2009, we had approximately $9.4 million of loans maturing in 2010
(including an aggregate of $2.92 million in March 2010 and $3.66 million in
April 2010). There can be no assurance that we will be able to refinance the
loans on acceptable terms or at all, and we do not have at this time the cash
necessary to repay the loans as they mature. If we do not refinance
or cannot repay our outstanding loans and we default on our obligations, the
lenders can demand accelerated payment and foreclose on collateral, our
financial condition would be materially adversely affected, and we could be
forced to cease operations. Furthermore, even if we are able to
obtain extensions on our existing loans, such extensions may include operational
and financial covenants significantly more restrictive than our current loan
covenants, which would adversely affect our plans and business
goals.
We
Incurred A Net Loss For The Year Ended December 31, 2009, And Our Business
Condition Is Uncertain.
Although
we have had a history prior to 2008 of positive income, working capital and
retained earnings, we incurred a net loss for the year ended December 31, 2009
of $6.80 million and working capital deficiency amounting to $6.9 million.
Additionally, putative class action lawsuits have been asserted against
us.
We
expended significant efforts to expand our revenues by assisting its sales
representatives and increasing our marketing efforts during fiscal 2009. The net
loss in 2009 was caused primarily by increased selling expenses, legal,
auditing, sales representative assistance and marketing expenses. The increase
in selling expense in 2009 was mainly due to the fact that beginning in March
2009, in order to develop a better channel for selling our products and to
increase our revenue in the face of fierce industry competition, we began to
build relationships with high quality sales agents and terminated our
relationships with agents with poor historical performance. Moreover, we believe
it is in our-long-term best interest to grow our operations through the
over-the-counter (“OTC”) market, which will produce higher profit margins.
Accordingly, we incurred increased costs in developing the OTC market in
2009.
In
addition, we have to defend against a consolidated putative class
action lawsuit that alleges that we failed to take adequate steps to ensure our
financial reporting comported with U.S. Generally Accepted Accounting Principles
(“GAAP”) and that, as a result, we were required to restate what are alleged to
be materially false and misleading financials for accounting periods during the
alleged class period from August 2007 through August 20, 2008, and further
alleges, among other things, that certain of our SEC filings and other public
statements contained false and misleading statements which resulted in damages
to the plaintiffs and the members of the purported class when they purchased our
securities. The Company believes the allegations in the amended consolidated
complaint are without merit, and intends to vigorously defend the class action
lawsuits. The Company does not believe the outcome of this suit will have a
material adverse effect on the Company. However, the Company is unable at this
time to predict the outcome of this litigation or whether the Company will incur
any liability associated with the litigation, or to estimate the effect such
outcome would have on the financial condition, results of operations, or cash
flows of the Company.
15
Our
Current Business Is Primarily Based On A Single Product, Which Currently
Accounts For Approximately 85% Of Our Revenues, And We May Not Be Able To
Generate Significant Revenue If This Product Fails.
Approximately
85% of our sales for the year ended December 31, 2009 comes from a single
product, Xuesaitong Soft Capsules, and our business may fail if this product
fails or generates materially less sales revenues. If we experience delays,
increased expenses, or other difficulties in the manufacture and sale of the
Xuesaitong Soft Capsules, or if our licenses and government approvals are
revoked to sell the product then we may not be able to generate significant
revenues or profitability, and our business and financial condition would be
materially adversely affected and we could be forced to cease operations, in
which case investors may lose all or part of their investment in our
company.
We
Rely On A Few Suppliers For Sanchi, The Primary Ingredient in Most of Our
Products, And Any Disruption With Our Suppliers Could Delay Product Shipments
And Have a Material Adverse Impact on Our Business Operations And
Profitability.
Due to
the limited availability of Sanchi, we currently rely on a small number of
suppliers as our source for Sanchi, the primary raw material that is needed for
us to produce our products. We believe that there are few alternative suppliers
available to supply the Sanchi plant, and should any of our current suppliers
terminate their business arrangements with us or increase their prices of
materials supplied, it would delay product shipments and adversely affect our
business operations and profitability. In addition, if the suppliers refused to
sell Sanchi, or increased the sales prices of Sanchi, this would also have a
material adverse impact on the results of operations.
If
Our Primary Product Is Replaced By Other Medicines, Is Removed From China’s
Insurance Catalogue In The Future, Or Cannot be Listed on Key Independent
Insurance Catalogues of the Various Provinces, Our Revenue Will Suffer
Substantially.
Under
Chinese regulations, patients purchasing medicines listed by China’s state
and/or provincial governments in the insurance catalogues, which include the
State Insurance Catalogue and the insurance catalogues of various provinces
(“PIC”), may be reimbursed, in part or in whole, by a social medicine fund.
Accordingly, pharmaceutical distributors prefer to engage in the distribution of
medicines listed in the Insurance Catalogue or the PICs. Since 2005, our main,
Xuesaitong Soft Capsules, has been listed in the Insurance Catalogue. The
content of the Insurance Catalogue is subject to change by the Ministry of Labor
and Social Security of China, and new medicines may be added to the Insurance
Catalogue by provincial level authorities as part of their limited ability to
change certain medicines listed in the Insurance Catalogue. Xuesaitong Soft
Capsules accounted for approximately 85% of our sales for the year ended
December 31, 2009. Since this product will be removed from the Insurance
Catalogue as of July 1, 2010, if the capsules are not then listed on certain key
PICs or another manner is not found to reimburse patients for the purchase of
their product, our total revenue will suffer substantially and we could be
forced to cease operations.
We
May Need To Raise Additional Capital To Fund Our Operations And Failure To Raise
Additional Capital May Force Us To Delay, Reduce, Or Eliminate Our Product
Development Programs.
Due to
the large amount of funds required for research and development and the
subsequent marketing of products, the pharmaceutical industry is very capital
intensive. The industry is characterized by small receivable turnovers, which
could mean that we will need more working capital if our revenues increase. We
have traditionally been committed to research and development and it is possible
that we will need to raise additional capital within the foreseeable future.
Additional capital may be needed for the development of new products or product
lines, advances to sales representatives, financing of general and
administrative expenses, licensing or acquisition of additional technologies,
and marketing of new or existing products. There are no assurances that we will
be able to raise the appropriate amount of capital needed for our future
operations. Failure to obtain funding when needed may force us to delay, reduce,
or eliminate our product development programs.
16
Currently,
all of the Company’s land, buildings and machinery are collateral securing
certain bank loans. If we default on the repayment obligations when due, the
properties may be foreclosed upon by the lenders, and our operations would be
materially adversely affected and we might cease to be able to operate as a
going concern.
We
May Have Difficulty Establishing Adequate Management, Legal And Financial
Controls In The PRC.
PRC
companies have historically not adopted a Western style of management and
financial reporting concepts and practices, which includes strong corporate
governance, internal controls, and computer, financial and other control
systems. In addition, we have had difficulty in hiring and retaining a
sufficient number of qualified employees to work in the PRC, including employees
trained in U.S. GAAP. As a result of these factors, we have had and continue to
have difficulty in establishing management, legal and financial controls,
collecting financial data and preparing financial statements, books of account
and corporate records and instituting business practices that meet Western
standards. We have experienced difficulties in implementing and maintaining
adequate internal controls as required under Section 404 of the Sarbanes-Oxley
Act of 2002, resulting in significant deficiencies and material weaknesses in
our internal controls which could impact the reliability of our financial
statements and prevent us from complying with SEC rules and regulations and the
requirements of the Sarbanes-Oxley Act of 2002. This occurred in
2008, and caused the restatement of our financial statements for fiscal 2007 and
the first quarter of 2008, and the temporary suspension of trading in our stock
on the NYSE Amex. Any such deficiencies, weaknesses or lack of compliance could
have a materially adverse effect on our business.
Matters
Relating To Or Arising From Our Recent Restatement And Weaknesses In Our
Internal Controls Has Had and May Continue to Have A Material Adverse Effect On
Our Business, Operating Results And Financial Condition, Including Increased
Costs and Diversion of Management’s Attention.
In
connection with the restatement of our previously issued financial statements
for the fiscal year ended December 31, 2007 and the fiscal quarter ended March
31, 2008 and our assessments of our disclosure controls and procedures under
Item 307 of Regulation S-K, management concluded that as of December 31, 2007,
December 31, 2008 and December 31, 2009, our disclosure controls and procedures
were not effective and that we had material weaknesses in our internal control
over financial reporting. Please refer to the discussion under Item 9A,
“Controls and Procedures” for further discussion of our material weaknesses as
of December 31, 2009. Should we be unable to remediate those or any other
material weaknesses promptly and effectively, such weaknesses could harm our
operating results, result in a material misstatement of our financial
statements, cause us to fail to meet our financial reporting obligations or
prevent us from providing reliable and accurate financial reports or avoiding or
detecting fraud. This, in turn, could result in a loss of investor confidence in
the accuracy and completeness of our financial reports, which could have an
adverse effect on our stock price. Any litigation or other proceeding or adverse
publicity relating to the restatement or material weaknesses could have a
material adverse effect on our business and operating results. In addition, we
have incurred substantial unanticipated costs for accounting and legal fees and
may continue to incur accounting and legal fees in connection with these
matters, and our management’s time and attention has been diverted from our
other business operations, which could harm our business.
Our
Three Largest Customers Account For A Significant Percentage of Our Sales. We
Cannot Be Certain That These Sales Will Continue; If They Do Not, Our Revenues
Will Likely Decline.
Our three
largest customers accounted for approximately 19.8%, 19.4% and 32.1% of our
sales for the years ended December 31, 2009, 2008 and 2007, respectively. We do
not have any long-term contracts with these customers, each of whom orders only
on a “purchase order” basis. There can be no assurances that any of these
customers will continue to purchase products from us. The loss of any or all of
these customers or a significant reduction in their orders would have a
materially adverse effect on our revenues.
17
The
Failure To Manage Growth Effectively Could Have An Adverse Effect On Our
Business, Financial Condition, And Results Of Operations.
The rapid
market growth, if any, of our pharmaceutical products may require us to expand
our employee base for managerial, operational, financial, and other purposes. As
of December 31, 2009, we had 556 full-time, salaried employees, in addition to
our employment of over 612 sales representatives who are paid on a commission
basis. The continued future growth will impose significant added
responsibilities upon the members of our management to identify, recruit,
maintain, integrate, and motivate new employees. Aside from increased
difficulties in the management of human resources, we may also encounter working
capital issues, as we need increased liquidity to finance the purchases of raw
materials and supplies, research and development of new products, acquisition of
new businesses and technologies, and the hiring of additional employees. For
effective growth management, we will be required to continue improving our
operations, management, and financial systems and control. Our failure to manage
growth effectively may lead to operational and financial inefficiencies that
will have a negative effect on our profitability.
Our
Planned Expansion Of Sales Into Overseas Markets Could Fail, Reduce Operating
Results And/Or Expose Us To Increased Risks Associated With Different Market
Dynamics And Competition In Any Of The Foreign Countries Where We Attempt To
Sell Our Products.
We would
face many new obstacles in our planned expansion of product sales in overseas
markets. These markets are untested for our products and we face risks in
expanding our business overseas, which include differences in regulatory product
testing requirements, patent protection, taxation policy, legal systems and
rules, marketing costs, fluctuations in currency exchange rates and changes in
political and economic conditions. We may not be as successful as our
competitors in generating revenues in international markets due to the lack of
recognition of our products or other factors. Developing product recognition
overseas is expensive and time-consuming and our international expansion efforts
may be more costly and less profitable than we expect. If we are not successful
in our target markets, our sales could decline, our margins could be negatively
impacted and we could lose market share, any of which could materially harm our
business, results of operations and profitability.
We
Are Dependent On Certain Key Personnel And Loss Of These Key Personnel Could
Have A Material Adverse Effect On Our Business, Financial Condition And Results
Of Operations.
Our
success is, to a certain extent, attributable to the management, sales and
marketing, and pharmaceutical factory operational expertise of key personnel.
Gui Hua Lan, our Chief Executive Officer, Zheng Yi Wang, our Executive Director
of Exports, Feng Lan, our President, Lei Lan, our Vice President, and Chuanxiang
Huang, our Chief Financial Officer, perform key functions in the operation of
our business. There can be no assurance that we will be able to retain these
officers after the term of their employment contracts expire. The loss of these
officers could have a material adverse effect upon our business, financial
condition, and results of operations. We must attract, recruit and retain a
sizeable workforce of technically competent employees. Our ability to
effectively implement our business strategy will depend upon, among other
factors, the successful recruitment and retention of additional highly skilled
and experienced management and other key personnel. We cannot assure that we
will be able to hire or retain such employees.
Our
Business And The Success Of Our Products Could Be Harmed If We Are Unable To
Maintain Our Brand Image.
We
believe that establishing and strengthening our Lixuwang brand is critical to
achieving widespread acceptance of our products and to establishing key
strategic relationships. The importance of brand recognition will increase as
current and potential competitors enter the Chinese pharmaceutical market with
competing products. Our ability to promote and position our Lixuwang brand
depends largely on the success of our marketing efforts and our ability to
provide high quality products and customer service. These activities are
expensive and we may not generate a corresponding increase in sales to justify
these costs. If we fail to establish and maintain our brand, or if our brand
value is damaged or diluted, we may be unable to maintain or increase our sales
or revenue.
We
Face Intense Competition In The Pharmaceutical Industry And Such Competition
Could Cause Our Sales Revenue And Profits To Decline.
The
pharmaceutical industry both within China and globally is intensely competitive
and is characterized by rapid and significant technological progress, and our
operating environment is increasingly competitive. We face intense competitors
that will attempt to create or are marketing products in the PRC that are
similar to our products. Our competitors, both domestic and international,
include large pharmaceutical companies, universities, and public and private
research institutions that currently engage in or may engage in efforts related
to the discovery and development of new pharmaceuticals. Many of these entities
have substantially greater research and development capabilities and financial,
scientific, manufacturing, marketing and sales resources than we do, as well as
more experience in research and development, clinical trials, regulatory
matters, manufacturing, marketing and sales. There can be no assurance that our
products will be either more effective in their therapeutic abilities and/or be
able to compete in price with that of our competitors. Failure to do either of
these may result in decreased profits.
18
If
Our Pharmaceutical Products Fail To Receive Regulatory Approval Or Are Severely
Limited In These Products’ Scope Of Use, We May Be Unable To Recoup Considerable
Research And Development Expenditures.
The
production of our pharmaceutical products is subject to the regulatory approval
of the State Food and Drug Administration (SFDA) in China. The regulatory
approval procedure for pharmaceuticals can be quite lengthy, costly, and
uncertain. Depending upon the discretion of the SFDA, the approval process may
be significantly delayed by additional clinical testing and require the
expenditure of resources not currently available; in such an event, it may be
necessary for us to abandon our application. Even where approval of the product
is granted, it may contain significant limitations in the form of narrow
indications, warnings, precautions, or contra-indications with respect to
conditions of use. If approval of our product is denied, abandoned, or severely
limited in terms of the scope of products use, it may result in the inability to
recoup considerable research and development expenditures. In this regard, in
2009, two non-prescription supplemental pharmaceutical products, Levofloxacin
Hydrochloride Soft Capsules and Brufen Soft Capsules, for which we had applied
for production approval, were rejected by SFDA under its new, stricter
regulatory procedures, and we are now unable to recoup those R&D
investments.
Currently,
two of our products, Wei Dingkang Soft Capsules and Dencichine Hemostat, have
pending applications with the SFDA. Phase II clinical testing for Wei DingKang
Soft Capsules was completed in December 2007. Phase II exploratory
and enhanced clinical trials have commenced and are expected to be completed by
August 2010, after which Phase III will start. We anticipate
obtaining production approval by the end of 2012. Dencichine Hemostat completed
a second review and was required to undergo neurotoxicity testing which may take
a significant amount of time. In addition, clinical testing and audit
processes are out of our control, so we must allow for additional time. The
Chinese Military Medical Institute performs these tests. The risk is that if we
do not receive timely approval for either of these drugs, then production will
be delayed and sales of the products cannot be planned for.
If
All Or A Significant Portion Of Our Customers With Trade Receivables Fail To Pay
All Or Part Of The Trade Receivables Or Delay The Repayment, Our Net Income Will
Decrease And Our Profitability Will Be Adversely Affected.
As of
December 31, 2009, our accounts receivable (less allowance for doubtful accounts
of $2.05 million) were $12.1 million. The standard credit period for most of our
new clients is two months. For certain clients, such as long-standing clients or
large clients, we will extend the credit period. Currently, most of our clients
have established a long-term corporate relationship with us, so their credit
periods are generally six months. Within the medical industry in China, the
collection period is generally longer than for other industries. Our estimated
average collection period for the year ended December 31, 2009 was 90 to 140
days. There is no assurance that our trade receivables will be fully repaid on a
timely basis. If all or a significant portion of our customers with trade
receivables fail to pay all or part of the trade receivables or delay the
payment due to us for whatever reason, our net profit will decrease and our
profitability will be adversely affected, and our liquidity will be adversely
affected.
Our
Success Is Highly Dependent On Continually Developing New And Advanced Products,
Technologies, And Processes And Failure To Do So May Cause Us To Lose Our
Competitiveness In The Pharmaceutical Industry And May Cause Our Profits To
Decline.
To remain
competitive in the pharmaceutical industry, it is important to continually
develop new and advanced products, technologies, and processes. There is no
assurance that our competitors’ new products, technologies, and processes will
not render our existing products obsolete or non-competitive. Our
competitiveness in the pharmaceutical market therefore relies upon our ability
to enhance our current products, introduce new products, and develop and
implement new technologies and processes. The research and development of new
products and technologies is costly and time consuming, and there are no
assurances that our research and development of new products will either be
successful or completed within the anticipated timeframe, if at all. Our failure
to technologically evolve and/or develop new or enhanced products may cause us
to lose our competitiveness in the pharmaceutical industry and may cause our
profits to decline.
19
If
We Fail To Develop New Products With High Profit Margins And Our High Profit
Margin Products Are Substituted By Competitor’s Products, Our Gross And Net
Profit Margins Will Be Adversely Affected.
The
pharmaceutical industry is very competitive, and there may be pressure to reduce
sale prices of products without a corresponding decrease in the price of raw
materials. In addition, the medical industry in China is highly competitive and
new products are constantly being introduced to the market. In order to increase
the sales of our products and expand our market, we may be forced to reduce
prices in the future, leading to a decrease in gross profit margin. To the
extent that we fail to develop new products with high profit margins and our
high profit margin products are substituted by competitors’ products, our gross
profit margins will be adversely affected.
The
Commercial Success Of Our Products Depends Upon The Degree Of Market Acceptance
Among The Medical Community And Failure To Attain Market Acceptance Among The
Medical Community May Have An Adverse Impact On Our Operations And
Profitability.
The
commercial success of our products depends upon the degree of market acceptance
among the medical community, such as hospitals and physicians. Even if our
products are approved by the SFDA, there is no assurance that physicians will
prescribe or recommend our products to patients. Furthermore, a product’s
prevalence and use at hospitals may be contingent upon our relationship with the
medical community. The acceptance of our products among the medical community
may depend upon several factors, including but not limited to, the product’s
acceptance by physicians and patients as a safe and effective treatment, cost
effectiveness, potential advantages over alternative treatments, and the
prevalence and severity of side effects. Failure to attain market acceptance
among the medical community may have an adverse impact on our operations and
profitability.
Our
Primary Product Is Subject To Price Controls By The China Government, Which May
Affect Both Our Revenues And Net Income.
The laws
of the PRC provide for the government to fix and adjust prices. Our primary
product Xuesaitong Soft Capsules was subject to price controls which affected
our gross profit, gross margin and net income. It is possible that additional
products may be subject to price control, or that price controls may be
increased in the future. 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 costs, our
profitability will be effectively subject to regulatory authorities in the
PRC.
Our
Certificates, Permits, And Licenses Related To Our Pharmaceutical Operations Are
Subject To Governmental Control And Renewal And Failure To Obtain Renewal Will
Cause All Or Part Of Our Operations To Be Terminated.
We are
subject to various PRC laws and regulations pertaining to the pharmaceutical
industry. We have attained certificates, permits, and licenses required for the
operation of a pharmaceutical enterprise and the manufacturing of pharmaceutical
products in the PRC. We also obtained pharmaceutical products and health food
GMP certificates. The pharmaceutical production permit and GMP certificates are
valid for a term of five years and the health food certifications are valid for
four year terms, and each must be renewed before their expiration. We originally
obtained our Medicine Production Permit on November 4, 1996, which is valid
until December 31, 2010. The Medicine Production Permit applies to products
described as tablet, granule, capsule, soft capsule, powder, ointment and
medicinal. If the permit expires without renewal, we will not be able to operate
medicine production which will cause our operations to be terminated. We intend
to apply for a renewed Medicine Production Permit before our current production
permit expires on December 31, 2010.
We hold
numerous GMP certificates that expire, as follows:
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a GMP certificate for ointment
products that expires on June 12,
2011;
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20
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a GMP certificate for powder
products that expires on March 5,
2014;
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a GMP certificate for products in
the form of tablet, granule, capsule, and soft capsule that expires on
July 18, 2012; and
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a GMP certificate for health food
products in the form of tablets, capsules, soft capsules, and granules
that expires on December 25,
2012.
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We intend
to apply for renewal of these GMP certificates prior to expiration. During the
renewal process, we will be re-evaluated by the appropriate governmental
authorities and must comply with the then-prevailing standards and regulations
which may change from time to time. In the event that we are not able to renew
the certificates, permits and licenses, all or part of our operations may be
terminated. Furthermore, if escalating compliance costs associated with
governmental standards and regulations restrict or prohibit any part of our
operations, our operations and profitability may be materially adversely
affected.
We
Cannot Guarantee The Protection Of Our Intellectual Property Rights And If
Infringement Or Counterfeiting Of Our Intellectual Property Rights Occurs, Our
Reputation And Business May Be Adversely Affected.
To
protect the reputation of our products, we have registered and applied for
registration of our trademarks in the PRC where we have a major business
presence. Our products are sold under these trademarks. There is no assurance
that there will not be any infringement of our brand name or other registered
trademarks or counterfeiting of our products in the future. Should any such
infringement or counterfeiting occur, our reputation and business may be
adversely affected. We may also incur significant expenses and substantial
amounts of time and effort to enforce our intellectual property rights in the
future. Such diversion of our resources may adversely affect our existing
business and future expansion plans.
The
Success of Our Expansion Into the Retail Distribution Of Our Cosmetic Products
Through Counters Depends On Our Ability To Open And Operate A Certain Number Of
New Counters On An Ongoing Basis, Which Could Strain Our Resources And Cause The
Performance Of Our Existing Operations To Suffer.
We have
been opening a number of retail specialty counters to offer our cosmetic
products at pharmacies throughout Eastern China, and have expanded our retail
presence across China. Our retail strategy will largely depend on our ability to
find sites for, open and operate retail locations successfully. Our ability to
open and operate retail locations successfully depends on several factors,
including, among others, our ability to:
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identify suitable counter
locations, the availability of which is outside our
control;
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purchase and negotiate acceptable
lease terms;
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prepare counters for opening
within budget;
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source sufficient levels of
inventory at acceptable costs to meet the needs of
counters;
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hire, train and retain
personnel;
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secure required governmental
permits and approvals;
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successfully integrate counters
into our existing
operations;
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contain payroll costs;
and
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generate sufficient operating
cash flows or secure adequate capital on commercially reasonable terms to
fund our retail strategy
plans.
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21
Any
failure to successfully open and operate retail counters for our cosmetic
products could have a material adverse effect on our results of operations. In
addition, our proposed retail plan will place increased demands on our
operational, managerial and administrative resources. These increased demands
could cause us to operate our business less effectively, which, in turn, could
cause deterioration in the financial performance of our overall
business.
We
Expect to Lose Certain Preferential Tax Concessions, Which May Cause Our Tax
Liabilities To Increase And Our Profitability To Decline.
We enjoy
preferential tax concessions in the PRC as a high-tech enterprise. We had a tax
preference for 2008, as determined by the PRC government and the regional tax
authorities. On March 16, 2007, the National People’s Congress of China enacted
a new PRC Enterprise Income Tax Law (the “EIT Law”), under which
domestic-invested enterprises and foreign-invested entities will be subject to
enterprise income tax at a uniform rate of 25% unless they qualify under certain
limited exceptions. The new law became effective on January 1,
2008. During the transition period for enterprises established before
March 16, the tax rate will gradually increase starting in 2008 and will be
equal to the new tax rate in 2012. All subsidiaries which are non-manufacturers
will be subject to the EIT Law.
Because
of the EIT Law, our tax liabilities will increase and our profits may
accordingly decline as our reduced income tax rate is no longer applicable
and/or the tax relief on investment in PRC is no longer available. Any future
increase in the enterprise income tax rate applicable to us or other adverse tax
treatments will increase our tax liabilities and reduce our net income. Further,
any future increase in the enterprise income tax rate applicable to us or other
adverse tax treatments, such as the discontinuation of preferential tax
treatments for high and new technology enterprises altogether, would have a
material adverse effect on our results of operations and financial
condition.
We
Do Not Carry Insurance To Cover Any Losses Due To Fire, Casualty Or Theft At Our
Production Facility Located In Kunming, China.
We have
not obtained fire, casualty and theft insurance, and there is no insurance
coverage for our raw materials, goods and merchandise, furniture and buildings
in China. Any losses incurred by us will have to be borne by us without any
assistance, and we may not have sufficient capital to cover material damage to,
or the loss of, our production facility due to fire, severe weather, flood or
other cause, and such damage or loss would have a material adverse effect on our
financial condition, business and prospects.
The
Internal Investigation Of Our Accounting Practices And The Restatement Of Our
Previous Financial Statements May Result In Additional Litigation And Could
Adversely Affect Our Business, Financial Condition And Results Of
Operations.
The Audit
Committee conducted an internal investigation of our recently disclosed
accounting errors, and we have restated our previously filed financial
statements for fiscal year 2007 and the quarter ended March 31, 2008
(Restatement). The internal investigation and restatement have exposed us to
risks and expenses associated with litigation, regulatory proceedings and
government enforcement actions. Certain putative class action lawsuits have been
asserted against us and certain of our officers and directors. No assurance can
be given regarding the outcome of such litigation, and additional claims may
arise. The investigation and Restatement and any settlements, payment of claims
and other costs could lead to substantial expenses, may materially affect our
cash balance and cash flows from operations and may divert management's
attention from the Company's business. In addition, the Restatement of our
financial statements could impact our reputation, including our relationships
with our investors and our customers, our ability to hire and retain qualified
personnel and, ultimately, our ability to generate revenue. Furthermore,
considerable legal and accounting expenses related to these matters have been
incurred to date and significant expenditures may continue to be incurred in the
future. We could be required to pay damages and might face remedies that could
harm our business, financial condition and results of
operations.
22
We
Do Not Carry Directors And Officers Liability Insurance To Cover Any Expenses
And Losses Due To Lawsuits Related To Financial Reporting Errors. Our
Indemnification Obligations Could Adversely Affect Our Business, Financial
Condition And Results Of Operations.
We have
not obtained directors and officers liability insurance to cover lawsuit
expenses and losses related to financial reporting errors. Our bylaws require us
to indemnify our current and former directors, officers, employees and agents
against most actions of a civil, criminal, administrative or investigative
nature. Generally, we are required to advance indemnification expenses prior to
any final adjudication of an individual’s culpability. The expense of
indemnifying our current and former directors, officers and employees and agents
in their defense or related expenses as a result of any actions related to the
internal investigation and financial restatement may be significant. Therefore,
our indemnification obligations could result in the diversion of our financial
resources and may adversely affect our business, financial condition and results
of operations.
We
May Suffer As A Result Of Product Liability Or Defective Products.
We may
produce products which inadvertently have an adverse pharmaceutical effect on
the health of consumers despite proper testing. Existing PRC laws and
regulations do not require us to maintain third party liability insurance to
cover product liability claims. However, if a product liability claim is brought
against us, it may, regardless of merit or eventual outcome, result in damage to
our reputation, breach of contract with our customers, decreased demand for our
products, costly litigation, product recalls, loss of revenue, and the inability
to commercialize some products.
We
Rely On The Cooperation With Research Laboratories And Universities, And If
These Institutions Cease To Cooperate With Us And We Cannot Find Other Suitable
Substitute Research And Development Partners, Our Ability To Develop New
Products May Be Hindered And Our Business May Be Adversely
Affected.
We
cooperate with several research institutions. We rely to a certain extent on
these institutions for our development of new products. There is no assurance
that these institutions will continue cooperating with us to develop new
products. In the event that these institutions cease to cooperate with us and it
cannot find other suitable substitute research and development partners, our
ability to develop new products may be hindered and our business may be
adversely affected.
RISKS
RELATED TO CONDUCTING BUSINESS IN CHINA
All
Of Our Assets Are Located In China And Substantially All Of Our Revenues Are
Derived From Our Operations In China, And Changes In The Political And Economic
Policies Of The PRC Government Could Have A Significant Impact Upon The Business
We May Be Able To Conduct In The PRC And Our Results Of Operations And Financial
Condition.
Our
business operations may be adversely affected by the current and future
political environment in the PRC. The PRC has operated as a socialist state
since the mid-1900s and is controlled by the Communist Party of China. The
Chinese government exerts substantial influence and control over the manner in
which we must conduct our business activities. The PRC has only permitted
provincial and local economic autonomy and private economic activities since the
1970s. The government of the PRC has exercised and continues to exercise
substantial control over virtually every sector of the Chinese economy,
particularly the pharmaceutical industry, through regulation and state
ownership. Our ability to operate in China may be adversely affected by changes
in Chinese laws and regulations, including those relating to taxation, import
and export tariffs, raw materials, environmental regulations, land use rights,
property and other matters. Under our current leadership, the government of the
PRC has been pursuing economic reform policies that encourage private economic
activity and greater economic decentralization. There is no assurance, however,
that the government of the PRC will continue to pursue these policies, or that
it will not significantly alter these policies from time to time without
notice.
23
The
PRC Laws And Regulations Governing Our Current Business Operations Are Sometimes
Vague And Uncertain. Any Changes In Such PRC Laws And Regulations May Have A
Material And Adverse Effect On Our Business.
The PRC’s
legal system is a civil law system based on written statutes, in which system
decided legal cases have little value as precedents unlike the common law system
prevalent in the United States. There are substantial uncertainties regarding
the interpretation and application of PRC laws and regulations, including but
not limited to the laws and regulations governing our business, obtaining
government approvals, and the enforcement and performance of our arrangements
with customers in the event of the imposition of statutory liens, death,
bankruptcy and criminal proceedings. The Chinese government has been developing
a comprehensive system of commercial laws, and considerable progress has been
made in introducing laws and regulations dealing with economic matters such as
foreign investment, corporate organization and governance, commerce, taxation
and trade. However, because these laws and regulations are relatively new, and
because of the limited volume of published cases and judicial interpretation and
their lack of force as precedents, interpretation and enforcement of these laws
and regulations involve significant uncertainties. There is no assurance that
the PRC government will continue to pursue these policies or that its position
on these issues will not change without notice. New laws and regulations that
affect existing and proposed future businesses may also be applied
retroactively. We are considered a foreign persons or foreign funded enterprises
under PRC laws, and as a result, we are required to comply with PRC laws and
regulations. We cannot predict what effect the interpretation of existing or new
PRC laws or regulations may have on our businesses. If the relevant authorities
find that we are in violation of PRC laws or regulations, they would have broad
discretion in dealing with such a violation, including, without
limitation:
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·
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levying
fines;
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revoking our business and other
licenses;
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requiring that we restructure our
ownership or operations; and
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requiring that we discontinue any
portion or all of our
business.
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The
Ability Of Our Chinese Operating Subsidiaries To Pay Dividends May Be Restricted
Due To Foreign Exchange Control Regulations Of China.
The
ability of our Chinese operating subsidiaries to pay dividends may be restricted
due to the foreign exchange control policies and availability of cash balance of
the Chinese operating subsidiaries. Because substantially all of our operations
are conducted in China and substantially all of our revenues are generated in
China, our revenue being earned and currency received are denominated in
Renminbi (RMB). RMB is subject to the exchange control regulation in China, and,
as a result, we may be unable to distribute any dividends outside of China due
to PRC exchange control regulations that restrict our ability to convert RMB
into US Dollars. Accordingly, we may not be able to access the Company’s PRC
funds which may not be readily available to us to satisfy obligations which have
been incurred outside the PRC, which could adversely affect our business and
prospects or our ability to meet our cash obligations.
The
Foreign Currency Exchange Rate Between U.S. Dollars And Renminbi Could Adversely
Affect Our Financial Condition.
To the
extent that we need to convert dollars into Renminbi for our operational needs,
our financial position and the price of our common stock may be adversely
affected should the Renminbi appreciate against the U.S. dollar at that time.
Conversely, if we decide to convert our Renminbi into dollars for the
operational needs or paying dividends on our common stock, the dollar equivalent
of our earnings from our subsidiary in China would be reduced should the dollar
appreciate against the Renminbi. We currently do not hedge our exposure to
fluctuations in currency exchange rates.
Until
1994, the Renminbi experienced a gradual but significant devaluation against
most major currencies, including dollars, and there was a significant
devaluation of the Renminbi on January 1, 1994 in connection with the
replacement of the dual exchange rate system with a unified managed floating
rate foreign exchange system. As a result, from 1994 to July 2005, the value of
the Renminbi relative to the U.S. dollar remained stable. Countries,
including the United States, argued that the Renminbi was artificially
undervalued due to China’s monetary policies and pressured China to allow the
Renminbi to float freely in world markets. In July 2005, the PRC government
changed its policy of pegging the value of the Renminbi to the dollar, and the
value of the Renminbi relative to the U.S. dollar has appreciated since then.
Under the new policy the Renminbi is permitted to fluctuate within a narrow and
managed band against a basket of designated foreign currencies. While the
international reaction to the Renminbi revaluation has generally been positive,
there remains significant international pressure on the PRC government to adopt
an even more flexible currency policy, which could result in further and more
significant appreciation of the Renminbi against the dollar.
24
Inflation
In The PRC Could Negatively Affect Our Profitability And Growth.
While the
PRC economy has experienced rapid growth, such growth has been uneven among
various sectors of the economy and in different geographical areas of the
country. Rapid economic growth can lead to growth in the money supply and rising
inflation. During the past two decades, the rate of inflation in China has been
as high as approximately 20%. According to the National Bureau of Statistics of
China, the inflation rate in China reached a 4.8% in 2007 and increased to a
high point of 5.9% in 2008. In 2009, the inflation rate is -0.7%. If prices for
our products rise at a rate that is insufficient to compensate for the rise in
the costs of supplies such as raw materials, it may have an adverse effect on
our profitability. In order to control inflation in the past, the PRC government
has imposed controls on bank credits, limits on loans for fixed assets and
restrictions on state bank lending. The implementation of such policies may
impede economic growth. Repeated rises in interest rates by the central bank
would likely slow economic activity in China which could, in turn, materially
increase our costs and also reduce demand for our products.
Recent
PRC Regulations Relating To Acquisitions Of PRC Companies By Foreign Entities
May Create Regulatory Uncertainties That Could Restrict Or Limit Our Ability To
Operate. Our Failure To Obtain The Prior Approval Of The China Securities
Regulatory Commission, Or The CSRC, For The Listing And Trading Of Our Common
Stock On NYSE Amex Could Have A Material Adverse Effect On Our Business,
Operating Results, Reputation And Trading Price Of Our Common
Stock.
The PRC
State Administration of Foreign Exchange, or SAFE, issued a public notice in
January 2005 concerning foreign exchange regulations on mergers and acquisitions
in China. The public notice states that if an offshore company controlled by PRC
residents intends to acquire a PRC company, such acquisition will be subject to
strict examination by the relevant foreign exchange authorities. The public
notice also states that the approval of the relevant foreign exchange
authorities is required for any sale or transfer by the PRC residents of a PRC
company’s assets or equity interests to foreign entities for equity interests or
assets of the foreign entities.
In April
2005, SAFE issued another public notice further explaining the January notice.
In accordance with the April notice, if an acquisition of a PRC company by an
offshore company controlled by PRC residents has been confirmed by a Foreign
Investment Enterprise Certificate prior to the promulgation of the January
notice, the PRC residents must each submit a registration form to the local SAFE
branch with respect to their respective ownership interests in the offshore
company, and must also file an amendment to such registration if the offshore
company experiences material events, such as changes in the share capital, share
transfer, mergers and acquisitions, spin-off transaction or use of assets in
China to guarantee offshore obligations. The April notice also provides that
failure to comply with the registration procedures set forth therein may result
in restrictions on our PRC resident shareholders and our subsidiaries. Pending
the promulgation of detailed implementation rules, the relevant government
authorities are reluctant to commence processing any registration or application
for approval required under the SAFE notices.
In
addition, on August 8, 2006, the Ministry of Commerce (“MOFCOM”), joined by the
State-Owned Assets Supervision and Administration Commission of the State
Council, State Administration of Taxation, State Administration for Industry and
Commerce, CSRC and SAFE, amended and released the Provisions for Foreign
Investors to Merge and Acquire Domestic Enterprises, new foreign-investment
rules which took effect September 8, 2006, superseding much, but not all, of the
guidance in the prior SAFE circulars. These new rules significantly revise
China’s regulatory framework governing onshore-offshore restructurings and how
foreign investors can acquire domestic enterprises. These new rules signify
greater PRC government attention to cross-border merger, acquisition and other
investment activities, by confirming MOFCOM as a key regulator for issues
related to mergers and acquisitions in China and requiring MOFCOM approval of a
broad range of merger, acquisition and investment transactions. Furthermore, the
new rules establish reporting requirements for acquisition of control by
foreigners of companies in key industries, and reinforce the ability of the
Chinese government to monitor and prohibit foreign control transactions in key
industries.
25
Specifically,
this regulation, among other things, has some provisions that purport to require
that an offshore special purpose vehicle, or SPV, formed for listing purposes
and controlled directly or indirectly by PRC companies or individuals shall
obtain the approval of the CSRC prior to the listing and trading of such SPV’s
securities on an overseas stock exchange. On September 21, 2006, the CSRC
published on its official website procedures specifying documents and materials
required to be submitted to it by SPVs seeking CSRC approval of their overseas
listings. However, the application of this PRC regulation remains unclear with
no consensus currently existing among the leading PRC law firms regarding the
scope and applicability of the CSRC approval requirement.
Because
we completed our restructuring before September 8, 2006, the effective date of
the new regulation, we believe it is not necessary for us to submit the
application to the CSRC for its approval, and the listing and trading of our
Common Stock on NYSE Amex does not require CSRC approval.
If the
CSRC or another PRC regulatory agency subsequently determines that CSRC approval
was required for our initial public offering that was completed in June 2007, we
may face regulatory actions or other sanctions from the CSRC or other PRC
regulatory agencies. These regulatory agencies may impose fines and penalties on
our operations in the PRC, limit our operating privileges in the PRC, delay or
restrict the repatriation of the proceeds of subsequent offerings into the PRC,
or take other actions that could have a material adverse effect on our business,
financial condition, results of operations, reputation and prospects, as well as
the trading price of our Common Stock. The CSRC or other PRC regulatory agencies
also may take actions requiring us, or making it advisable for us, to halt
future offerings before settlement and delivery of the Common Stock offered in
such future offerings. Consequently, if you engage in market trading
or other activities in anticipation of and prior to settlement and delivery, you
do so at the risk that settlement and delivery may not occur.
Also, if
the CSRC later requires that we obtain its approval, we may be unable to obtain
a waiver of the CSRC approval requirements, if and when procedures are
established to obtain such a waiver. Any uncertainties and/or negative publicity
regarding this CSRC approval requirement could have a material adverse effect on
the trading price of our Common Stock. Furthermore, published news reports in
China recently indicated that the CSRC may have curtailed or suspended overseas
listings for Chinese private companies. These news reports have created further
uncertainty regarding the approach that the CSRC and other PRC regulators may
take with respect to us.
These new
rules may significantly affect the means by which offshore-onshore
restructurings are undertaken in China in connection with offshore private
equity and venture capital financings, mergers and acquisitions. It is expected
that such transactional activity in China in the near future will require
significant case-by-case guidance from MOFCOM and other government authorities
as appropriate. It is anticipated that application of the new rules will be
subject to significant administrative interpretation, and we will need to
closely monitor how MOFCOM and other ministries apply the rules to ensure its
domestic and offshore activities continue to comply with PRC law. Given the
uncertainties regarding interpretation and application of the new rules, we may
need to expend significant time and resources to maintain
compliance.
It is
uncertain how our business operations or future strategy will be affected by the
interpretations and implementation of the SAFE notices and new rules. Our
business operations or future strategy could be adversely affected by the SAFE
notices and the new rules. For example, we may be subject to more stringent
review and approval process with respect to our foreign exchange
activities.
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.
26
Any
Recurrence Of Severe Acute Respiratory Syndrome, Avian Flu, Or Another
Widespread Public Health Problem, In The PRC Could Adversely Affect Our
Operations.
A renewed
outbreak of severe acute respiratory syndrome, avian flu or another widespread
public health problem in China, where all of our manufacturing facilities are
located and where all of our sales occur, could have a negative effect on our
operations. Such an outbreak could have an impact on our operations as a result
of:
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·
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quarantines or closures of some
of our manufacturing facilities, which would severely disrupt our
operations;
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the sickness or death of our key
officers and employees; and
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a general slowdown in the Chinese
economy.
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Any of
the foregoing events or other unforeseen consequences of public health problems
could adversely affect our operations.
A
Downturn In The Economy Of The PRC May Slow Our Growth And
Profitability.
The
growth of the Chinese economy has been uneven across geographic regions and
economic sectors. There can be no assurance that growth of the Chinese economy
will be steady or that any downturn will not have a negative effect on our
business, especially if it results in either a decreased use of our products or
in pressure on us to lower our prices. The downturn in the Chinese economy and
worldwide in 2008 and 2009 has had an adverse impact on the financial condition
of patients and hospitals, which in turn affects our pharmaceutical sales and
collection of trade receivables.
If
We Make Equity Compensation Grants To Persons Who Are PRC Citizens, They May Be
Required To Register With The State Administration Of Foreign Exchange Of The
PRC, Or SAFE. We May Also Face Regulatory Uncertainties That Could Restrict Our
Ability To Adopt An Equity Compensation Plan For Our Directors And Employees And
Other Parties Under PRC Law.
On April
6, 2007, SAFE issued the “Operating Procedures for Administration of Domestic
Individuals Participating in the Employee Stock Ownership Plan or Stock Option
Plan of An Overseas Listed Company,” also know as “Circular 78.” It is not clear
whether Circular 78 covers all forms of equity compensation plans or only those
which provide for the granting of stock options. For any plans which are so
covered and are adopted by a non-PRC listed company after April 6, 2007,
Circular 78 requires all participants who are PRC citizens to register with and
obtain approvals from SAFE prior to their participation in the plan. In
addition, Circular 78 also requires PRC citizens to register with SAFE and make
the necessary applications and filings if they participated in an overseas
listed company’s covered equity compensation plan prior to April 6, 2007. In
2009 we adopted, and our stockholders approved, our 2009 Stock Incentive Plan
pursuant to which we may make option grants to our officers and directors, most
of whom are PRC citizens. Circular 78 may require our officers and directors who
receive option grants and are PRC citizens to register with SAFE. We believe
that the registration and approval requirements contemplated in Circular 78 will
be burdensome and time consuming. If it is determined that any of our equity
compensation plans are subject to Circular 78, failure to comply with such
provisions may subject us and participants of our equity incentive plan who are
PRC citizens to fines and legal sanctions and prevent us from being able to
grant equity compensation to our PRC employees. In that case, our ability to
compensate our employees and directors through equity compensation would be
hindered and our business operations may be adversely affected.
You
May Experience Difficulties In Effecting Service Of Legal Process, Enforcing
Foreign Judgments Or Bringing Original Actions In China Based Upon U.S. Laws,
Including The Federal Securities Laws Or Other Foreign Laws Against Us Or Our
Management.
All of
our current operations are conducted in China. Moreover, all of our directors
and officers are nationals and residents of China. All or substantially all of
the assets of these persons are located outside the United States and in the
PRC. As a result, it may not be possible to effect service of process within the
United States or elsewhere outside China upon these persons. In addition,
uncertainty exists as to whether the courts of China would recognize or enforce
judgments of U.S. courts obtained against us or such officers and/or directors
predicated upon the civil liability provisions of the securities law of the
United States or any state thereof, or be competent to hear original actions
brought in China against us or such persons predicated upon the securities laws
of the United States or any state thereof.
27
RISKS
RELATED TO OUR CAPITAL STRUCTURE
If
We Default Under Our Loan Contract with Yunnan Shuang Long Branch of
Agricultural Bank of China, We Could Forfeit Part or All of Our Equity Interests
in Shenghuo China And Our Stock Price May be Substantially
Depressed.
The
Company’s bank facility with Shuang Long Branch of Agricultural Bank of China
(or ABC), executed on August 6, 2009, is secured by, among other things, a
pledge of the Company’s 94.95% shares in Shenghuo China, our main operating
subsidiary. Default by the Company under this loan facility, if not
waived or modified, would permit the ABC to accelerate the loan and enforce on
the pledged shares, and we may be forced to forfeit part or all of our equity
ownership interests in Shenghuo China. In addition, our stock price
may be substantially depressed as a result of the foreclosure or the sales of
the pledged shares.
The
Price Of Our Common Stock May Be Volatile, And If An Active Trading Market For
Our Common Stock Does Not Develop, The Price Of Our Common Stock May Suffer And
Decline.
We cannot
assure you that an active trading market will develop or be sustained or that
the market price of our common stock will not decline. The price of our common
stock is highly volatile and may fluctuate substantially due to many factors,
some of which are outside of our control.
Our
Common Stock Could Be At Risk Of Being Delisted By The NYSE Amex, Making It
More Difficult For Stockholders To Dispose Of Or To Obtain Accurate Quotations
As To The Value Of Their Stock.
Our
common stock currently trades on NYSE Amex (the “Exchange”). The Exchange, as a
matter of policy, will consider the suspension of trading in, or removal from
listing of any stock if, among other things, (i) the company fails to maintain
stockholder’s equity of at least $2 million if the company has sustained losses
from continuing operations or net losses in two of its three most recent fiscal
years, (ii) the company fails to maintain stockholder’s equity of $4 million if
the company has sustained losses from continuing operations or net losses in
three of its four most recent fiscal years; (iii) the company fails to maintain
stockholder’s equity of $6 million if the company has sustained losses from
continuing operations or net losses in its five most recent fiscal years; or
(iv) the company has sustained losses which are so substantial in relation to
its overall operations or its existing financial resources, or its financial
condition has become so impaired that it appears questionable, in the opinion of
the NYSE Amex, as to whether such issuer will be able to continue operations
and/or meet its obligations as they mature; or (v) it has been selling for a
substantial period of time at a low price per share and the issuer fails to
effect a reverse split of such shares within a reasonable time after being
notified that the Exchange deems such action to be appropriate. In its review,
the Exchange will consider all pertinent factors including, market conditions in
general, the number of shares outstanding, plans which may have been formulated
by management, applicable regulations of the state or country of incorporation
or of any governmental agency having jurisdiction over the issuer, the
relationship to other Exchange policies regarding continued listing, and, in
respect of securities of foreign issuers, the general practice in the country of
origin of trading in low-selling price issues. The delisting of our
common stock by the Exchange would adversely affect the price and liquidity of
our common stock.
Shares
Eligible For Future Sale May Adversely Affect The Market Price Of Our Common
Stock, As The Future Sale Of A Substantial Amount Of Outstanding Stock In The
Public Marketplace Could Reduce The Price Of Our Common Stock.
In June
2007, we completed a public offering and sale of 460,000 shares of common stock.
In addition, we registered 2,000,000 shares of common stock issued in a Private
Placement, and all lock up restrictions regarding these shares have expired. We
also registered 4,006,400 additional shares of common stock, effective September
19, 2007 (Registration No. 333-144959).
28
Additionally,
the former stockholders of Shenghuo China may be eligible to sell all or some of
our shares of common stock by means of ordinary brokerage transactions in the
open market pursuant to Rule 144, promulgated under the Securities Act (“Rule
144”), subject to certain limitations. In general, pursuant to Rule
144, a non-affiliate stockholder who has satisfied a six month holding period
may, under certain circumstances, sell shares under Rule 144 without any volume
limitation. Any substantial sale of common stock pursuant to any resale
prospectus or Rule 144 may have an adverse effect on the market price of our
common stock by creating an excessive supply.
After
March 31, 2009, no open market sales of securities covered by these
registrations will be permitted (other than sales pursuant to Rule 144) until a
new registration statement is filed and becomes effective.
Our
Principal Stockholder Has Significant Influence Over Us.
Our
largest shareholder, Lan’s Int’l Medicine Investment Co., Limited, or LIMI,
beneficially owns or controls approximately 77.3% of our outstanding shares. Gui
Hua Lan, our Chief Executive Officer, Feng Lan, our President, and Zheng Yi
Wang, our Executive Director of Exports, are directors of LIMI and have voting
and investment control over the shares owned by LIMI. In addition, Gui Hua Lan,
Feng Lan and Zheng Yi Wang own 62.42%, 5.15% and 1.45%, respectively, of LIMI’s
issued and outstanding shares, and Lei Lan, our Vice President, owns 9.37% of
LIMI. We have other officers and directors who also hold equity interests in
LIMI. LIMI has controlling influence in determining the outcome of any corporate
transaction or other matters submitted to our shareholders for approval,
including mergers, consolidations and the sale of all or substantially all of
our assets, election of directors, and other significant corporate actions. LIMI
also has the power to prevent or cause a change in control. In addition, without
the consent of LIMI, we could be prevented from entering into transactions that
could be beneficial to it. The interests of LIMI may differ from the interests
of our other shareholders.
The
Interests Of The Existing Minority Shareholder In Shenghuo China May Diverge
From Our Own Interests And This May Adversely Affect Our Ability To Manage
Shenghuo China.
Shenghuo
China, our principal operating subsidiary, is an equity joint venture in which
we directly own a 94.95% interest and Kunming Dian Jiao Investment Consulting
Co., Ltd., or Dian Jiao, owns the remaining 5.05% interest. Dian Jiao’s interest
may not be aligned with our interest at all times. If our interests diverge,
Dian Jiao may exercise its right under PRC laws and its consent rights to
protect its own interest, which may be adverse to us and our investors. Further,
should we wish to transfer our equity interest in Shenghuo China, in whole or in
part, to a third-party, Dian Jiao has a right of first refusal under China’s
joint venture regulations.
In
addition to its statutory rights as a minority shareholder, Dian Jiao has
additional rights under the joint venture contract and under the articles of
association of Shenghuo China. The joint venture contract and articles of
association require the consent of each of Shenghuo China’s shareholders and/or
unanimous board approval on matters such as a major change in the business line
of the company and expansion or amendment of the business scope of the
company.
Dian Jiao
has thus far been cooperative with us in handling matters with respect to the
business of Shenghuo China. There is no assurance, however, that Dian Jiao will
continue to act in a cooperative manner in the future.
The
Ability Of Our Chinese Operating Subsidiaries To Pay Dividends May Be Restricted
Due To Our Corporate Structure.
Substantially
all of our operations are conducted in China and substantially all of our
revenues are generated in China. As an equity joint venture, Shenghuo China is
required to establish reserve funds and staff and workers’ bonus and welfare
funds, each of which is appropriated from net profit after taxation but before
dividend distributions in accordance with Chinese law. Shenghuo China is
required to allocate at least 10% of our net profits to the reserve fund until
the balance of this fund has reached 50% of Shenghuo China’s registered
capital.
In
addition, the profit available for distribution from our Chinese subsidiaries is
determined in accordance with generally accepted accounting principles in China.
This calculation may differ from the one performed under generally accepted
accounting principles in the United States, or GAAP. As a result, we may not
receive sufficient distributions from our Chinese subsidiaries to enable us to
make dividend distributions to our stockholders in the future and limitations on
distributions of the profits of Shenghuo China could negatively affect our
financial condition and assets, even if our GAAP financial statements indicate
that our operations have been profitable.
29
If
We Fail To Maintain Effective Internal Controls Over Financial Reporting Or
Effective Disclosure Controls and Procedures, The Price Of Our Common Stock May
Be Adversely Affected.
Our
internal control over financial reporting or disclosure controls and procedures
currently have weaknesses and conditions that need to be addressed, the
disclosure of which may have an adverse impact on the price of our common stock.
We are required to establish and maintain appropriate internal controls over
financial reporting and disclosure controls and procedures. Failure to establish
those controls, or any failure of those controls once established, could
adversely impact our public disclosures regarding our business, financial
condition or results of operations. In addition, management’s assessment of
internal controls over financial reporting or disclosure controls and procedures
may identify weaknesses and conditions that need to be addressed in our internal
controls over financial reporting, disclosure controls and procedures or other
matters that may raise concerns for investors, as occurred in 2007 and 2008. Any
actual or perceived weaknesses and conditions that need to be addressed in our
internal control over financial reporting or disclosure controls and procedures
may have an adverse impact on the price of our common stock.
As of
December 31, 2009, our Chief Executive Officer (CEO) and our Chief Financial
Officer (CFO) performed an evaluation of our disclosure controls and procedures
and concluded that our disclosure controls and procedures had significant
deficiencies that resulted in material weaknesses in our controls and
procedures, resulting in them being ineffective. These deficiencies consisted
of: material adjustments related to the prior year audits were not recorded in
the company’s accounting records that were necessary to reconcile the retained
earnings to the prior year balances in accordance with U.S. GAAP and multiple
material adjustments were made as a result of audit procedures performed by the
external auditors. We expect to expend a significant amount of funds to address
these deficiencies and there is no guarantee that we will be able to resolve
these deficiencies, which may result in an adverse impact on the price of our
common stock.
Standards
For Compliance With Section 404 Of The Sarbanes-Oxley Act Of 2002 Are Uncertain,
And If We Fail To Comply In A Timely Manner, Our Business Could Be Harmed And
Our Stock Price Could Decline.
Rules
adopted by the SEC pursuant to Section 404 of the Sarbanes-Oxley Act of 2002
require annual assessment of our internal control over financial reporting, and
attestation of this assessment by our company’s independent registered public
accountants. We are currently required to conduct an annual
assessment of our internal controls, and the attestation requirement of
management’s assessment by our company’s independent registered public
accountants will first apply to our annual report for the 2010 fiscal year. The
standards that must be met for management to assess the internal control over
financial reporting as effective are new and complex, and require significant
documentation, testing and possible remediation to meet the detailed standards.
We may encounter problems or delays in completing activities necessary to make
an assessment of our internal control over financial reporting. In addition, the
attestation process by our independent registered public accountants is new and
it may encounter problems or delays in completing the implementation of any
requested improvements and receiving an attestation of our assessment by our
independent registered public accountants. If we cannot assess our internal
control over financial reporting as effective, or our independent registered
public accountants are unable to provide an unqualified attestation report on
such assessment once they are required to do so, investor confidence and share
value may be negatively impacted.
Our
Common Stock May Be Considered A “Penny Stock,” And Thereby Be Subject To
Additional Sale And Trading Regulations That May Make It More Difficult To
Sell.
Our
common stock may be considered to be a “penny stock” if it does not qualify for
one of the exemptions from the definition of “penny stock” under Section 3a51-1
of the Securities Exchange Act for 1934, as amended (the “Exchange Act”). Our
common stock may be a “penny stock” if it meets one or more of the following
conditions (i) the stock trades at a price less than $5.00 per share; (ii) it is
not traded on a “recognized” national exchange; (iii) it is not quoted on the
Nasdaq Capital Market, or even if so, has a price less than $5.00 per share; or
(iv) is issued by a company that has been in business less than three years with
net tangible assets less than $5 million.
30
The
principal result or effect of being designated a “penny stock” is that
securities broker-dealers participating in sales of our common stock will be
subject to the “penny stock” regulations set forth in Rules 15-2 through 15g-9
promulgated under the Exchange Act. For example, Rule 15g-2 requires
broker-dealers dealing in penny stocks to provide potential investors with a
document disclosing the risks of penny stocks and to obtain a manually signed
and dated written receipt of the document at least two business days before
effecting any transaction in a penny stock for the investor’s account. Moreover,
Rule 15g-9 requires broker-dealers in penny stocks to approve the account of any
investor for transactions in such stocks before selling any penny stock to that
investor. This procedure requires the broker-dealer to (i) obtain from the
investor information concerning his or her financial situation, investment
experience and investment objectives; (ii) reasonably determine, based on that
information, that transactions in penny stocks are suitable for the investor and
that the investor has sufficient knowledge and experience as to be reasonably
capable of evaluating the risks of penny stock transactions; (iii) provide the
investor with a written statement setting forth the basis on which the
broker-dealer made the determination in (ii) above; and (iv) receive a signed
and dated copy of such statement from the investor, confirming that it
accurately reflects the investor’s financial situation, investment experience
and investment objectives. Compliance with these requirements may make it more
difficult and time consuming for holders of our common stock to resell their
shares to third parties or to otherwise dispose of them in the market or
otherwise.
We
Do Not Foresee Paying Cash Dividends In The Foreseeable Future.
We
currently intend to retain any future earnings for funding growth. We do not
anticipate paying any dividends in the foreseeable future. As a result, you
should not rely on an investment in our securities if you require dividend
income. Capital appreciation, if any, of our shares may be your sole source of
gain for the foreseeable future. Moreover, you may not be able to resell your
shares in our company at or above the price you paid for them.
31
ITEM
1B. UNRESOLVED STAFF COMMENTS.
Smaller
reporting companies are not required to provide the information required by this
item.
ITEM
2. PROPERTIES.
We have
land use rights to two parcels of land with a total area of approximately 66.7
acres and own a 161,460 square foot factory. The land use rights for both
parcels have terms of 50 years and end in 2048 and 2050. Our principal executive
offices are located at No. 2, Jing You Road, Kunming National Economy &
Technology Developing District, People’s Republic of China 650217.
ITEM
3. LEGAL PROCEEDINGS.
Mingying Co.,
Ltd. Lawsuit – On July 20, 2009, the Company appeared before a court
sitting in the Tianhe District of Guangzhou, Guandong Province, People’s
Republic of China, to defend itself in an action brought by Mingying Co., Ltd.
for allegedly failing to satisfy payment obligations for advertising services.
Mingying Co., Ltd. is seeking a judgment in the amount of RMB 465,000
(approximately $68,000). The court has informed Mingying Co., Ltd. that it has
failed to meet its burden of proof in support of its claims, however the action
is still proceeding. The Company lost the lawsuit in the trial of first
instance, which was held in September. The Company has applied for a retrial and
the retrial was held on November 20, 2009 but the court has not yet pronounced
its judgment on the retrial.
The
Company intends to continue to vigorously defend the lawsuit. The Company does
not believe the outcome of this suit will have a material adverse effect on the
Company.
SEC
Investigation – The United States Securities and Exchange Commission
(“SEC”) had been conducting an informal inquiry regarding the events that
resulted in the Company’s restatement of its financial statements for the fiscal
year 2007 and the first quarter of 2008. The Company was represented by counsel
cooperated with the SEC’s inquiry on a voluntary basis. On September, 2009, the
Company received notification from the SEC that it had completed its
investigation and reached a determination not to recommend any
enforcement.
Class Action
Lawsuit – In 2008, putative class action lawsuits were asserted against
the Company and certain other parties in the United States District Court for
the Southern District of New York (the “Court”). On February 12, 2009, an
amended complaint was served on the Company by new lead counsel for the class,
consolidating the putative class actions and bearing the caption Beni Varghese,
Individually and on Behalf of All Other Similarly Situated v. China Shenghuo
Pharmaceutical Holdings, Inc., et al., Index No. 1:08 CIV. 7422. The defendants
include the Company, the Company’s controlling shareholders, Lan’s International
Medicine Investment Co., Limited, the Company’s chief executive officer, Gui Hua
Lan, the Company’s former chief financial officer, Qiong Hua Gao, and the
Company’s former independent registered public accounting firm, Hansen, Barnett
& Maxwell, P.C. Both the Company and the accounting firm filed
motions to dismiss the complaint, but those motions were denied by the
Court. A scheduling order has been entered by the Court anticipating
that the parties will engage in substantive discovery in 2010.
The
amended consolidated complaint alleges that the Company failed to take adequate
steps to ensure its financial reporting comported with U.S. Generally Accepted
Accounting Principles (“GAAP”) and, as a result, the Company was required to
restate what are alleged to be materially false and misleading financials for
accounting periods during the alleged class period from August 2007 through
August 20, 2008. The amended consolidated complaint further alleges, among other
things, that certain of the Company’s SEC filings and other public statements
contained false and misleading statements which resulted in damages to the
plaintiffs and the members of the purported class when they purchased the
Company’s securities. On the basis of those allegations, plaintiffs in each of
the actions seek an unspecified amount of damages under Sections 10(b) and 20(a)
of the Exchange Act, and Rule 10b-5 promulgated thereunder.
32
The
Company believes the allegations in the amended consolidated complaint are
without merit, and intends to vigorously defend the class action lawsuits. The
Company does not believe the outcome of this suit will have a material adverse
effect on the Company. However, the Company is unable at this time to predict
the outcome of this litigation or whether the Company will incur any liability
associated with the litigation, or to estimate the effect such outcome would
have on the financial condition, results of operations, or cash flows of the
Company.
ITEM
4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
33
PART
II
ITEM 5.
|
MARKET FOR REGISTRANT’S COMMON
EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY
SECURITIES.
|
Commencing
on June 14, 2007, our shares of common stock have been listed for trading on the
Exchange under the ticker symbol “KUN.” As of March 24, 2010, we had 10
registered shareholders.
For the
year ended December 31, 2009, the high and low sales prices for our common stock
are as set forth below. The closing sales price of our common stock on March 24,
2010 was $0.83 per share.
2009
|
||||||||
High
|
Low
|
|||||||
4th
Quarter
|
$
|
1.10
|
$
|
0.61
|
||||
3rd
Quarter
|
1.08
|
0.65
|
||||||
2nd
Quarter
|
1.25
|
0.29
|
||||||
1st
Quarter
|
0.90
|
0.16
|
The price
of our common stock will likely fluctuate in the future. The stock market in
general has experienced extreme stock price fluctuations in the past few years.
In some cases, these fluctuations have been unrelated to the operating
performance of the affected companies. Many companies have experienced dramatic
volatility in the market prices of their common stock. We believe that a number
of factors, both within and outside our control, could cause the price of our
common stock to fluctuate, perhaps substantially. Factors such as the following
could have a significant adverse impact on the market price of our common
stock:
|
·
|
Our ability to obtain additional
financing and, if available, the terms and conditions of the
financing;
|
|
·
|
Our financial position and
results of operations;
|
|
·
|
Concern as to, or other evidence
of, the reliability and efficiency of our products and services or our
competitors’ products and
services;
|
|
·
|
Announcements of innovations or
new products or services by us or our
competitors;
|
|
·
|
U.S. federal and state
governmental regulatory actions and the impact of such requirements on our
business;
|
|
·
|
The development of litigation
against us;
|
|
·
|
Period-to-period fluctuations in
our operating results;
|
|
·
|
Changes in estimates of our
performance by any securities
analysts;
|
|
·
|
The issuance of new equity
securities pursuant to a future offering or
acquisition;
|
|
·
|
Changes in interest
rates;
|
|
·
|
Competitive developments,
including announcements by competitors of new products or services or
significant contracts, acquisitions, strategic partnerships, joint
ventures or capital
commitments;
|
|
·
|
Investor perceptions of us;
and
|
|
·
|
General economic and other
worldwide or national
conditions.
|
34
Dividend
Policy
We have
not declared or paid any cash dividends on our common stock and we currently
intend to retain future earnings, if any, to finance the expansion of our
business. We do not expect to pay any cash dividends in the
foreseeable future. The decision whether to pay cash dividends on our common
stock will be made by our board of directors, at their discretion, and will
depend on our financial condition, operating results, capital requirements and
other factors that the board of directors considers significant. We currently
intend to retain our earnings for funding growth and, therefore, do not expect
to pay any dividends in the foreseeable future.
Equity
Compensation Plan
On June
15, 2009, our Board of Directors and stockholders adopted and approved our 2009
Stock Incentive Plan (the “2009 Plan”). The 2009 Plan allows for
awards of stock options for up to 2,000,000 shares of common
stock. As of December 31, 2009, no options to purchase common stock
had been granted under the 2009 Plan.
As of
December 31, 2009, the following warrants are outstanding:
|
# of securities to be
issued upon exercise
of outstanding
options, warrants
and rights
|
Exercise price of
outstanding
options, warrants
and rights
|
# of securities
remaining available
for future issuance
under equity
compensation plans
(excluding securities
reflected in column
|
|||||||||
Warrants
granted to Westpark Capital in 2007
|
40,000
|
4.20
|
-
|
|||||||||
Warrants
granted to two of our non-employee directors in 2007
|
6,000
|
3.50
|
-
|
|||||||||
Warrants
granted to CCG Investor Relations Partners LLC in
2007
|
200,000
|
3.50
|
-
|
|||||||||
Total
|
246,000
|
|
-
|
Recent
sales of unregistered securities
None.
ITEM
6. SELECTED FINANCIAL DATA.
Smaller
reporting companies are not required to provide the information required by this
item.
35
ITEM
7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS.
Forward-Looking
Statements
The
following Management’s Discussion and Analysis (“MD&A”) is intended to help
the reader understand the results of operations and financial condition of China
Shenghuo Phamaceutical holdings Inc. Throughout this document, references to
“we,” “our,” the “Company” refer to China Shenghuo Phamaceutical holdings Inc
and its subsidiaries. MD&A should be read in conjunction with our financial
statements and the related notes, and the other financial information included
in this report.
This
filing contains forward-looking statements. The words “anticipated,” “believe,”
“expect, “plan,” “intend,” “seek,” “estimate,” “project,” “could,” “may,” and
similar expressions are intended to identify forward-looking statements. These
statements include, among others, information regarding future operations,
future capital expenditures, and future net cash flow. Such statements reflect
our management’s current views with respect to future events and financial
performance and involve risks and uncertainties, including, without limitation,
our ability to repay certain bank loans due in 2010, general economic and
business conditions; changes in foreign, political, social, and economic
conditions; our expansion into the retail distribution of our cosmetic products;
regulatory initiatives and compliance with governmental regulations; the ability
to achieve further market penetration and additional customers; and various
other matters, many of which are beyond our control. Should one or more of these
risks or uncertainties occur, or should underlying assumptions prove to be
incorrect, actual results may vary materially and adversely from those
anticipated, believed, estimated or otherwise indicated. Consequently, all of
the forward-looking statements made in this report are qualified by these
cautionary statements and there can be no assurance of the actual results or
developments. Refer to the sections entitled “Risk Factors” and “Special Note
Regarding Forward-Looking Statements” contained in this report.
Overview
We are
primarily engaged in the research, development, manufacture, and marketing of
pharmaceutical, nutritional supplement and cosmetic products. Almost all of our
products are derived from the medicinal herb Panax notoginseng, also known as
Sanqi, Sanchi or Tienchi. Panax notoginseng is the root of the greyish-brown or
greyish-yellow plant that only grows in a few geographic locations, among which
is the Yunnan Province in southwest China, where we are located; this province
accounts for 90% of the total global production. The main root of Panax
notoginseng are cylindrical shaped and are most commonly one to six centimeters
long and one to four centimeters in diameter. Panax notoginseng saponins (PNS),
the active ingredients in Panax notoginseng, are extracted from the plant using
high-tech equipment and in accord with Good Manufacturing Practice (GMP)
standards. Our main product, Xuesaitong Soft Capsules, accounted for
approximately 85% of our sales for the year ended December 31, 2009 as compared
to more than 87% of our sales for the year ended December 31, 2008.
We earn
revenues mainly from the production and sale of our products and external
processing. We hope to increase profits as a result of making new products and
increasing sales, since the sale of products is our main source for generating
cash. Our business involves a significant degree of risk as a result of the
opportunities and challenges we face in selling our products. We have
traditionally focused on research and development of products serving
cardiovascular and cerebrovascular disease, peptic ulcer disease and health
products markets. However, we intend to devote additional resources
to research and development and to continue to evaluate and develop additional
high-tech product candidates to expand our pipeline where we perceive an unmet
need and commercial potential and to improve existing products to enhance their
efficacy.
With
intense price competition among many similar or identical products in the
industry, we believe that building brand equity is the primary means to generate
and sustain profitable growth in the future. Our brand strategy is centered on
“Lixuwang”—the brand under which most of our products are sold. We believe that
our relationships within the Chinese pharmaceutical industry are key to building
brand equity, and we believe we can benefit from developing and maintaining
relationships with professionals within the industry, especially physicians and
hospitals.
36
Since
2005, our primary product, Xuesaitong Soft Capsules has been listed in Part B of
the State Insurance Catalogue. Xuesaitong Soft Capsules represented
approximately 85% of our sales for the year ended December 31, 2009. In addition
to the State Insurance Catalogue, each of the 31 Chinese provinces establishes
its own PIC. A drug listed on the PIC will result in the patient purchasing such
drug to receive the same 90% reimbursement as if such drug were listed on Part B
of the State Insurance Catalogue. In November 2009, the Ministry of Labor and
Social Security in China announced the updated State Insurance Catalogue, which
takes effect on July 1, 2010, and the Xuesaitong Soft Capsules will no longer be
listed. Therefore, until the effective date of the updated State Insurance
Catalogue, the Xuesaitong Soft Capsules will remain in Part B of the State
Insurance Catalogue. We are seeking to have other products listed in the
Insurance Catalogue. At present, it has been announced that Banlangen Tables,
Dansheng Tables and Sulfadiazine Silver Ointment have already been approved to
be listed in the newly announced State Insurance Catalogue. The Ministry of
Labor and Social Security in China plans to update the State Insurance Catalogue
every two years, but since 2000, the catalog has been updated only
twice.
In order
to mitigate the negative impact the removal from the State Insurance Catalogue
may have on the Company, we have been coordinating with various provinces to
list the Xuesaitong Soft Capsules on the various PICs and our communications
with various provinces are great. It is expected that the various provinces will
make a decision on their individual listings by May 30, 2010.
Further,
the Department of Heath in China, which makes an independent assessment of the
drugs available, publishes an “essential drug list” as to what drugs are basic
and prevalent and can satisfy the ordinary need for drugs to all the people. If
a drug is listed on the “essential drug list,” it is automatically included in
Part A of the State Insurance Catalogue. The Company’s Xuesaitong Soft Capsules
were listed on the “essential drug list” in 2000 and 2004 and the Company is
attempting to have the drug relisted on that list in 2010 to mitigate and even
improve its position with respect to drug reimbursement for
patients.
Xuesaitong
Soft Capsules are subject to wholesale and retail price controls by the Chinese
government, and are primarily sold in China, and are also sold in various
developing countries, including Malaysia, Indonesia and Kyrgyzstan. Sales of the
product in China are regulated by the State Food and Drug Administration
(“SFDA”) as a prescription drug and therefore must be sold to consumers through
hospital pharmacies and cannot be advertised, thus limiting the ability of the
company to market the brand. Our three largest customers are Guangzhou
Pharmaceutical, Ltd.; Yunnan Province Pharmaceutical, LTD.; and Beijing Ai’xin
Weiye Medicine, LTD, all of which accounted for 6.1%, 7.9% and 5.8% of our sales
for the year ended December 31, 2009.
As of
December 31, 2009, our medicine marketing team maintains sales offices in
approximately 31 provinces throughout China. The sales network covers
approximately 210 cities and is staffed by approximately 612 sales
representatives. We intend to grow our internal marketing and sales function and
increase our relationships with other potential customers to expand the
distribution and presence of our non-prescription brands and
cosmetics.
We hope
to further expand sales beyond China into other countries where our products
could be affordable treatment options. We intend to focus on the expansion of
our cosmetics product line and devote additional marketing and sales resources
to that end with the aim that our cosmetics products will account for a larger
percentage of our revenue in the future.
Our
business is capital intensive, and these research and development, marketing,
sales network expansion and cosmetic product expansion initiatives will require
us to expend significant cash resources, which could adversely affect our
profitability and liquidity. We do face certain challenges and risks, including
our relatively high debt ratio, which is one of our main risks. We have
encountered a shortage of working capital and are exploring possible ways to
address our short and long term cash needs.
We
believe that among the most important economic or industry-wide factors relevant
to our growth in the short term is the reform of the medical system in China and
the adjustment of medicine prices, which will affect the sale of our main
product, Xuesaitong Soft Capsules, in hospitals. In order to increase long-term
growth, we have applied for the designation of Xuesaitong Soft Capsules as a
medicine with “good quality worthy of high price,” which we received in February
2007. Currently, the Chinese government supports the medical system in urban and
rural communities.
37
According
to data from the Yunnan Pharmaceutical Industry Association, the pharmaceutical
industry in China grew about 21.02% on a year-over-year basis in 2009. This
growth was driven by a number of favorable factors including improving standards
of living from an increase in disposable income, an aging population, the
improving access and higher participation in the State Basic Medical Insurance
System, and the increase in government spending on public health
care.
In
January 21, 2009, the Chinese government announced a healthcare reform plan
proposing the government spend upward of RMB850 billion over the next three
years to make medical services and products more affordable and accessible to
the entire population. We believe the successful implementation of the policies
outlined in the plan will have a significant impact on the domestic
pharmaceutical sector. There are five key tasks the healthcare reforms are
aiming to address: 1) to expand medical insurance coverage and increase
participation rate, 2) set up a national basic drug system, 3) establishment of
an extensive public health system, 4) increasing the efficiency and improve the
quality of basic medical services, especially in the rural areas, and 5) reform
state-owned hospitals.
Traditional
Chinese Medicine (“TCM”), including prescription and over-the-counter
pharmaceuticals, have been widely used in China for many years and are an
important part of the overall Chinese culture. The recently announced healthcare
reform plan contains measures and policies that we believe will help support and
promote the growth and development of the domestic TCM market. TCM drug
manufacturers are likely to benefit from this reform as we believe the
government will add more TCM-related drugs to the national medicine catalog. In
addition, we expect the government will focus on disease prevention as it rolls
out the nationwide medical insurance coverage. The TCM market is a vibrant and
growing industry despite the challenging economic environment and it will remain
a part of mainstream medicine in China.
We hope
to stabilize the sales channel into hospitals and widen the reach of sales in
urban and rural communities at the same time. Large increases in medicine sales
at an average lower price will ensure the growth of general medicinal sales over
the next few years. Also, we are focusing our efforts on developing better
channels for selling our products to expand our revenue and to counter fierce
market competition. To that extend, we began to build relationships with new
high-quality sales agents and terminate our relationships with sales agent with
poor historical performances during 2009. We believe that this shift will
provide a sound foundation for our operations going forward.
Our 12
WaysTM Chinese
Traditional Medicine Beauty Salon Series (“12 Ways”) cosmetic products are sold
in a number of cities and provinces outside our local region. We have opened a
number of retail specialty counters to offer our cosmetic products at pharmacies
throughout Eastern China, eventually expanding our retail presence across China.
As of December 31, 2009, we have opened approximately 618 retail specialty
counters in more than 30 cities throughout China. In addition, we opened a 12
Ways Chinese Herbal Beauty Salon in Kunming that will feature approximately ten
traditional Chinese medicine practitioners and beauticians that provide a
variety of services, including acupuncture, body massage, foot massage and other
services. All products used in the salon will be supplied by us. Management
hopes that the opening of this salon and the opening of retail counters will
allow us to increase our brand recognition and strengthen marketing. Our ability
to effectively open and operate new retail locations depends on several factors,
including, among others, our ability to identify suitable counter locations, the
availability of which is outside our control; our ability to prepare counters
for opening within budget; our ability to hire, train and retain personnel; our
ability to secure required governmental permits and approvals; our ability to
contain payroll costs; and our ability to generate sufficient operating cash
flows or secure adequate capital on commercially reasonable terms to fund short
term cash needs and our expansion plans.
There is
potential for growth in production and sales due to the growth of new products
and expansion of new channels into urban and rural communities. However, it will
be uncertain which of our new products will pass the applicable tests and get
clinical approval without difficulty because of the uncertainty of test results
and clinical approvals. Over the last three years, the price of the main raw
material we use - sanchi - has been fluctuating, which will likely increase our
cost of product sold. In addition, our expected increased expenses for research
and development, marketing and sales may have an adverse affect on future profit
levels and available cash resources.
38
Company
History
We were
incorporated in the State of Delaware on May 24, 2005. We were originally
organized as a “blank check” shell company to investigate and acquire a target
company or business seeking the perceived advantages of being a publicly held
corporation. Our principal business operations from inception to August 31,
2006, to closing of the Share Exchange, was to achieve long-term growth
potential through a combination with a business rather than immediate,
short-term earnings. On June 30, 2006, we entered into a Share Exchange
Agreement (the “Exchange Agreement”) with Kunming Shenghuo Pharmaceutical
(Group) Co., Ltd. (“Shenghuo China”) and Lan’s Int’l Medicine Investment Co.,
Limited, a Hong Kong corporation and shareholder holding 93.75% of the equity
interest of Shenghuo China (“LIMI”). On August 11, and 28, 2006, the parties
entered into Amendment No. 1 and 2 to the Exchange Agreement, respectively.
Pursuant to the Exchange Agreement, as amended, we agreed to issue an aggregate
of 16,255,400 shares of our common stock to LIMI and its designees in exchange
for 93.75% of the equity interest of Shenghuo China (the “Share Exchange”). The
Share Exchange closed on August 31, 2006. Upon the closing of the Share
Exchange, we (i) became the 93.75% parent of Shenghuo China, (ii) assumed the
operations of Shenghuo China and its subsidiaries and (iii) changed our name
from SRKP 8, Inc. to China Shenghuo Pharmaceutical Holdings, Inc.
On June
18, 2007, the Board of Shenghuo China resolved to increase the registered
capital of Shenghuo China by $734,348.09 from $9,665,017 to $10,399,365. As a
result, we own approximately 94.95% of the equity interests of Shenghuo China,
and Kunming Dian Jiao Investment Consulting Co., Ltd. or Dian Jiao owns
approximately 5.05% of the equity interests of Shenghuo China.
Shenghuo
China owns a 99% equity interest in Kunming Shenghuo Medicine Co., Ltd., a 99%
equity interest in Kunming Pharmaceutical Importation and Exportation Co., Ltd.,
a 98.18% interest in Kunming Shenghuo Cosmetics Co., Ltd., and a 70% interest in
Kunming Beisheng Science and Technology Development Co., Ltd. On April 30, 2009,
the Company formed Shi Ling Shenghuo Co., Ltd. (“Shi Ling”) as a wholly owned
subsidiary. Shi Ling was formed for the purpose of purchasing or leasing land
suitable for cultivating the medicinal herb Panax notoginseng for use in the
production of the Company’s medicinal products. All of these entities are formed
in and operate within the PRC.
Recent
Events
Restatement
of Financial Statements for the Fiscal Year 2007 and the First Fiscal Quarter of
2008
During
the third quarter of 2008, the Audit Committee of the Board of Directors of the
Company (the “Audit Committee”) conducted an internal investigation based on
preliminary information received from Hansen, Barnett & Maxwell, P.C.
(“HBM”), the independent registered public accounting firm of the Company,
regarding errors in the accounting for certain sales representative commission
advances and trade receivables, the Company’s internal controls, the Company’s
personnel involved and related matters. These errors resulted in the
understatement of general and administrative expenses (the line item that
includes bad debt allowance) and the resultant overstatement of net income and
earnings per share. The errors also resulted in an overstatement of the deferred
tax asset, which could adversely affect future operations and profit levels on a
continuing basis. The Audit Committee found no evidence to suggest that the
accounting errors were made at the direction of, or with the knowledge or
involvement of, the Company’s executive officers and management, and the Audit
Committee determined that the actions of the two supervisors responsible for the
errors were not intended to manipulate the Company’s reported results or
financial statements. The Company restated its financial statements for the
fiscal year ended December 31, 2007 and the fiscal quarter ended March 31, 2008
(the only periods found to have been impacted by the accounting errors) to
correct the accounting errors.
Based on
the Audit Committee’s recommendations, the Company implemented the following
remedial measures in order to prevent similar accounting errors from occurring
in the future: (1) dismissed the two supervisors in the Company’s financial
department who were responsible for the erroneous journal entries; (2) provided
additional training in compliance with Section 404 of the Sarbanes-Oxley Act of
2002 and financial document production and record retention to the Company’s
finance personnel and other personnel who provide financial data that is
incorporated into the Company’s financial statements; (3) accelerated the
process of improving its disclosure controls and procedures and internal
controls over financial reporting (which included documentation of policies and
procedures by the end of 2008 and will include implementation in January 2009 in
compliance with Section 404 of the Sarbanes-Oxley Act of 2002 following the COSO
framework); and (4) replaced Qiong Hua Gao, the Company’s former Chief Financial
Officer, with Wendy Fu as the new Chief Financial Officer, who is more
experienced in the application of generally accepted accounting principles in
the United States. Wendy Fu resigned on August 24, 2009 for reasons unrelated to
the restatement of financial statements for the fiscal year 2007 and the first
fiscal quarter of 2008. Chuanxiang Huang was appointed as our Chief Financial
Officer on August 24, 2009.
39
As
previously reported in the Company’s Form 10KSB/A, filed on November 14, 2008,
the effects of the Restatement of the financial statements for the fiscal year
2007 were as follows:
|
As
Previously
Reported
|
Effect of
Restatement
|
As
Restated
|
|||||||||
Consolidated
Balance Sheet
|
||||||||||||
As
of December 31, 2007
|
||||||||||||
Accounts
and notes receivable, net
|
$
|
9,651,304
|
$
|
916,368
|
$
|
10,567,672
|
||||||
Employee
advances, net
|
10,147,415
|
(1,897,609
|
)
|
8,249,806
|
||||||||
Total
Current Assets
|
27,581,623
|
(981,241
|
)
|
26,600,382
|
||||||||
Deferred
Income Taxes
|
1,593,159
|
(1,593,159
|
)
|
-
|
||||||||
TOTAL
ASSETS
|
37,910,118
|
(2,574,400
|
)
|
35,335,718
|
||||||||
Minority
Interest in Net Assets of Subsidiaries
|
655,962
|
(176,644
|
)
|
479,318
|
||||||||
Stockholders'
Equity:
|
||||||||||||
Retained
earnings
|
6,335,590
|
(2,296,253
|
)
|
4,039,337
|
||||||||
Accumulated
other comprehensive income, foreign currency translation
|
1,031,146
|
(101,503
|
)
|
929,643
|
||||||||
Total
Stockholders' Equity
|
13,709,654
|
(2,397,756
|
)
|
11,311,898
|
||||||||
TOTAL
LIABILITIES AND STOCKHOLDERS' EQUITY
|
37,910,118
|
(2,574,400
|
)
|
35,335,718
|
||||||||
Consolidated
Statement of Operations
|
||||||||||||
For
the year ended December 31, 2007
|
||||||||||||
General
and administrative expense
|
4,935,754
|
942,194
|
5,877,948
|
|||||||||
Total
Operating Expenses
|
12,048,873
|
942,194
|
12,991,067
|
|||||||||
Income
from Operations
|
2,886,755
|
(942,194
|
)
|
1,944,561
|
||||||||
Income
Before Income Taxes
|
2,332,820
|
(942,194
|
)
|
1,390,626
|
||||||||
Benefit
from (provision for) income taxes
|
1,978,963
|
(1,529,765
|
)
|
449,198
|
||||||||
Minority
interest in income of subsidiaries
|
(295,143
|
)
|
175,706
|
(119,437
|
)
|
|||||||
Net
Income
|
4,016,640
|
(2,296,253
|
)
|
1,720,387
|
||||||||
Foreign
currency translation adjustment
|
810,273
|
(101,503
|
)
|
708,770
|
||||||||
Comprehensive
Income
|
4,826,913
|
(2,397,756
|
)
|
2,429,157
|
||||||||
Earnings
Per Share
|
||||||||||||
Basic
|
0.21
|
(0.12
|
)
|
0.09
|
||||||||
Diluted
|
0.21
|
(0.12
|
)
|
0.09
|
||||||||
Consolidated
Statement of Cash Flows
|
||||||||||||
For
the year ended December 31, 2007
|
||||||||||||
Cash
Flows from Operating Activities:
|
||||||||||||
Net
income
|
4,016,640
|
(2,296,253
|
)
|
1,720,387
|
||||||||
Deferred
income taxes
|
(1,002,915
|
)
|
1,529,764
|
526,849
|
||||||||
Minority
interest in income of subsidiaries
|
295,143
|
(175,706
|
)
|
119,437
|
||||||||
Change
in current assets and liabilities:
|
||||||||||||
Accounts
and notes receivable
|
900,437
|
(879,905
|
)
|
20,532
|
||||||||
Employee
advances
|
(7,024,869
|
)
|
1,822,100
|
(5,202,769
|
)
|
|||||||
Net
Cash Used in Operating Activities
|
(5,036,769
|
)
|
-
|
(5,036,769
|
)
|
40
We
consider the policies discussed below as critical to understanding our
Consolidated Financial Statements, as their application places the most
significant demands on management’s judgment, since financial reporting results
rely on estimates of the effects of matters that are inherently uncertain. In
instances where different estimates could have reasonably been used, we
disclosed the impact of these different estimates on our operations. In certain
instances, like revenue recognition, the accounting rules are prescriptive;
therefore, it would not have been possible to reasonably use different
estimates. Changes in assumptions and estimates are reflected in the period in
which they occur. The impact of such changes could be material to our results of
operations and financial condition in any quarterly or annual
period.
Specific
risks associated with these critical accounting policies are discussed
throughout the MD&A, where such policies affect our reported and expected
financial results. For a detailed discussion of the application of these and
other accounting policies, refer to Note 2 – Summary of significant accounting
policies, in the Consolidated Financial Statements.
Allowance
for Doubtful Accounts and Credit Losses
Accounts
receivable are reviewed periodically as to whether they are past due based on
contractual terms and their carrying values have become impaired. An allowance
for doubtful accounts is recorded in the period in which loss is determined to
be probable based on an assessment of specific evidence indicating doubtful
collection, historical experience, account balance aging and prevailing economic
conditions. Measurement of such losses requires consideration of historical loss
experience, including the need to adjust for current conditions, and judgments
about the probable effects of relevant observable data, including present
economic conditions such as delinquency rates and financial health of specific
customers. We have considered all available information in our assessments of
the adequacy of the provision for doubtful accounts and we do not expect there
would be significant changes on conditions that would result in material effect
on the allowance estimation. We will continue to assess our receivable portfolio
in light of the current economic environment and its impact on our estimation of
the adequacy of the allowance for doubtful accounts.
Income
Taxes and Tax Valuation Allowances
We
follows Statement of Financial Accounting Standard (“SFAS”) No. 109, “Accounting
for Income Taxes” (“ASC Topic 740”), which requires the recognition of deferred
tax assets and liabilities for the expected future tax consequences of events
that have been included in the financial statements or tax returns. Under this
method, deferred income taxes are recognized for the tax consequences in future
years of differences between the tax bases of assets and liabilities and their
financial reporting amounts at each period end based on enacted tax laws and
statutory tax rates, applicable to the periods in which the differences are
expected to affect taxable income. Valuation allowances are established, when
necessary, to reduce deferred tax assets to the amount expected to be
realized.
We
regularly review our deferred tax assets for recoverability considering
historical profitability, projected future taxable income, the expected timing
of the reversals of existing temporary differences and tax planning strategies.
The ultimate realization of deferred tax assets is dependent upon the generation
of future taxable income and tax planning strategies in making this assessment.
If we are unable to generate sufficient future taxable income, or if there is a
material change in the actual effective tax rates or time period within which
the underlying temporary differences become taxable or deductible, we could be
required to increase the valuation allowance against all or a significant
portion of our deferred tax assets resulting in a substantial adverse impact on
our operating results.
Legal
Contingencies
We are
involved in class action lawsuits as discussed in Note 13 – commitments and
contingencies in the Consolidated Financial Statements. We determine whether an
estimated loss from a contingency should be accrued by assessing whether a loss
is deemed probable and can be reasonably estimated. We assess our potential
liability by analyzing our litigation and regulatory matters using available
information. Should developments in any of these matters cause a change in our
determination as to an unfavorable outcome and result in the need to recognize a
material accrual, or should any of these matters result in a final adverse
judgment or be settled for significant amounts, they could have a material
adverse effect on our results of operations, cash flows and financial position
in the period or periods in which such change in determination, judgment or
settlement occurs.
41
We
believe the allegations in the amended consolidated complaint are without merit,
and intend to vigorously defend the class action lawsuits. We do not believe the
outcome of this suit will have a material adverse effect on us. However, we are
unable at this time to predict the outcome of this litigation or whether we will
incur any liability associated with the litigation, or to estimate the effect
such outcome would have on the financial condition, results of operations, or
cash flows based on the opinion of the counsel.
42
Results
of Operations
The
following table sets forth our results of operations for the years ended
December 31, 2009 and 2008.
Year ended December 31,
|
||||||||||||||||
2009
|
2008
|
Change ($)
|
Variance %)
|
|||||||||||||
Sales
|
$ | 36,001,915 | $ | 28,690,509 | $ | 7,311,406 | 25 | % | ||||||||
Cost
of Goods Sold
|
9,887,969 | 7,693,635 | 2,194,334 | 29 | % | |||||||||||
Gross
Margin
|
26,113,946 | 20,996,874 | 5,117,072 | 24 | % | |||||||||||
Operating
Expenses:
|
||||||||||||||||
Selling
expenses
|
26,281,103 | 13,274,942 | 13,006,161 | 98 | % | |||||||||||
General
and administrative expenses
|
6,920,489 | 10,856,184 | (3,935,695 | ) | -36 | % | ||||||||||
Research
and development expenses
|
139,944 | 338,546 | (198,602 | ) | -59 | % | ||||||||||
33,341,536 | 24,469,672 | 8,871,864 | 36 | % | ||||||||||||
Loss from
Operations
|
(7,227,590 | ) | (3,472,798 | ) | (3,754,792 | ) | 108 | % | ||||||||
Other
Expenses:
|
623,645 | 967,150 | (343,505 | ) | -36 | % | ||||||||||
Loss
Before Income Tax
|
(7,851,235 | ) | (4,439,948 | ) | (3,411,287 | ) | 77 | % | ||||||||
Income
tax (expense) benefit
|
1,053,980 | (438,279 | ) | 1,492,259 | -340 | % | ||||||||||
Net
Loss
|
(6,797,255 | ) | (4,878,227 | ) | (1,919,028 | ) | 39 | % | ||||||||
Net
loss attributable to noncontrolling interests
|
(243,534 | ) | (235,318 | ) | (8,216 | ) | 3 | % | ||||||||
Net
Loss Attributable to Stockholders
|
$ | (6,553,721 | ) | $ | (4,642,909 | ) | (1,910,812 | ) | 41 | % | ||||||
Basic
and diluted loss per share
|
$ | (0.33 | ) | $ | (0.24 | ) | (0.10 | ) | 42 | % | ||||||
Weighted-average
number of shares outstanding-basic and diluted
|
19,679,400 | 19,679,400 | - | - |
Fiscal
Years Ended December 31, 2009 and 2008
Sales:
Sales for the year ended December 31, 2009 were approximately $36
million, an increase of approximately $7.3 million, or 25%, from approximately
$28.7 million for the year ended December 31, 2008. The increase in sales was
primarily due to our implementation of a new sales policy that has stimulated
the enthusiasm of sales representatives and resulted in the increased sales of
products.
43
Cost of sales:
Our cost of sales for the year ended December 31, 2009 was approximately
$9.9 million, an increase of $2.2 million, or 29 %, from approximately $7.7
million for the year ended December 31, 2008. The increase in cost of sales was
primarily due to the increase of sales.
Gross margin:
Our gross margin for the year ended December 31, 2009 was approximately
$26.1 million as compared with approximately $21 million for the year ended
December 31, 2008. Gross margin as a percentage of revenues was approximately
72.53% for the year ended December 31, 2009, a down of 0.65% from 73.18 % for
the year ended December 31, 2008. The decrease in gross margin percentage was
primarily due to the increasing price of raw material.
Selling expenses:
Selling expenses were approximately $26.3 million for the year ended
December 31, 2009, an increase of approximately $13 million, or 98%, from
approximately $13.3 million for the year ended December 31, 2008. The increase
in selling expense in 2009 was mainly due to two facts. First, beginning in
March 2009, in order to develop a better channel for selling our products and to
increase our revenue in the face of fierce industry competition, we began to
build relationships with new high-quality agents and terminated our
relationships with agents with poor historical performance, as a result of which
we were required to pay greater commissions, travelling and entertainment
expenses to establish good relationships with the new high-quality agents.
Second, we believe it is in our long-term best interest to grow our operations
through the over-the-counter (“OTC”) market, which will produce higher profit
margins. Accordingly, we began developing the OTC market in 2009 and as of
December 31, 2009, revenue from the OTC market comprises approximately 10% of
the total sales revenue for Medicine. For the year ended December 31, 2009, the
expenditures for developing our presence in the OTC market are approximately RMB
5 million and that we will have to dedicate significant funds in the future to
continue to develop in the OTC market. As we are focusing our operations on the
OTC market, we have adopted a policy to absorb a significantly higher percentage
of costs incurred by our sales representatives than in the past in order to
foster their cooperation in developing the OTC market. The costs being borne by
us with respect to developing the OTC market are being accrued in selling
expenses.
We
reimburse the sales representatives their selling and marketing expenses when
they submit the appropriate documentation to be reimbursed and their sales are
collected. We reimburse the sales representatives their accrued selling expenses
when related accounts receivable are collected.
General and
administrative expenses: General and administrative expenses were
approximately $6.9 million for the year ended December 31, 2009, a decrease of
approximately $3.9million, or 36%, from approximately $10.9 million for the year
ended December 31, 2008. The decrease was primarily due to (i) reduction of bad
debt loss (ii) our strengthened budget control over expense disbursements to
reduce unnecessary expense.
Research and
development expenses: Research and development expense for the year ended
December 31, 2009 was $0.14 million as compared to $0.34 million for the year
ended December 31, 2008. The decrease was primarily due to our focus on a few
innovative pharmaceuticals instead of on a number of generic drugs.
Net other
expense: Net other expense, which includes interest income, income from
research and development activities, subsidy income, interest expense and other
income and expenses, was $0.62 million for the year ended December 31, 2009 as
compared to $0.97 million for the year ended December 31, 2008, a decrease of
$0.35 million, or 36%. The decrease in net other expense was primarily due to a
decrease in the interest expense on borrowings.
Income tax
(expense) benefit: Benefit from income taxes was $1 million for the year
ended December 31, 2009 as compared to a provision for income tax of
approximately $0.4 million for the year ended December 31, 2008. Benefits from
income tax were mainly generated from unpaid accrued expenses and from losses
carried forward, which we believed that would be able to be realized by
implementing a tax planning strategy.
Net loss
attributable to stockholders: We incurred a net loss of $6.6 million for
the year ended December 31, 2009 as compared to a net loss of $4.6 million for
the year ended December 31, 2008, an increase in net loss of approximately $2
million. The increase in net loss was primarily due to the sharp increase of $13
million in selling expense.
44
Liquidity
and Capital Resources
General –
As of December 31, 2009, we had cash and cash equivalents of $ 1.9 million. We
have historically financed our business operations through bank loans, in
addition to equity offerings. Although the we had a history prior to 2008 of
positive net income, working capital and retained earnings, we have incurred a
net loss for the year ended December 31, 2009 of $6.8 million and we had an
accumulated deficit of $7.2 million as of December 31, 2009, primarily due to
the losses in the year ended December 31, 2009 and the loss of $4.9 million for
fiscal 2008. Our consolidated current liabilities exceeded its consolidated
current assets by $6.9 million as of December 31, 2009, and $0.1 million as of
December 31, 2008.
We have
expended significant efforts to expand its revenues by assisting its sales
representatives and increasing its marketing efforts during the twelve months
ended December 31, 2009 and during fiscal 2008. The net loss for the year ended
December 31, 2009 was caused primarily by increased selling expenses, legal,
sales representative assistance and marketing expenses. The increase in the
selling expense in 2009 was mainly due to the fact that beginning in March 2009,
in order to develop a better channel for selling our products and to increase
our revenue in the fierce industry competition, we began to build relationships
with high quality agents and terminated our relationships with agents with poor
historical performance. Moreover, we believe it is in our -long-term best
interest to grow our operations through the over-the-counter (“OTC”) market,
which will produce higher profit margins. Accordingly, we began developing the
OTC market in 2009. We believes that after expending funds to develop new agents
in 2009, we will be able to decrease selling and sales representative assistance
expenses in the near future as the daily operations between new agents and the
Company becomes more efficient. In addition, the Company may be forced to give
significant attention to the class action lawsuits discussed in Note 13 in the
Consolidated Financial Statements.
For the
year ended December 31, 2009, we had net cash provided by operating activities
of $2.5 million, an increase of over $ 0.55 million from 1.95 million for the
year ended December 31, 2008. We believe that we would be able to obtain more
cash flows from operating activities accompanying the increasing sales
volume.
Cash
flow
|
Years ended December 31,
|
||||||
2009
|
2008
|
||||||
(in
thousands)
|
|||||||
Net
cash provided by operating activities
|
$ | 2,499 | $ | 1,947 | |||
Net
cash used in investing activities
|
$ | (3,121 | ) | $ | (304 | ) | |
Net
cash (used in) provided by financing activities
|
$ | 992 | $ | (3,009 | ) | ||
Cash
and Cash Equivalents at End of Period
|
$ | 1,987 | $ | 1,612 |
Operating Activities: Net cash
provided from operating activities for the year ended December 31, 2009 was
$2.5million, as compared to net cash provided in operating activities of $1.95
million for the year ended December 31, 2008. These results reflect the impacts
of (i) an increase of approximately $1.5 million deposits prepaid by sales
representatives and an increase of $0.7 million advance from
customers.
Investing Activities: Net cash
used in investing activities was $3.1 million for the year ended December 31,
2009, as compared to net cash used in the amount of $0.3 million for the year
ended December 31, 2008. The increase in net cash used in investing activities
was primarily due to increases in capital expenditures, specifically, the
construction of Shenghuo Plaza.
45
Financing Activities: Net cash
provided by financing activities was approximately $1 million for the year ended
December 31, 2009 compared to net cash used in the amount of $3 million for the
year ended December 31, 2008. The increase in cash provided was primarily due to
the increase of loans borrowed from banks.
Working Capital
Deficiency
Our
consolidated current liabilities exceeded our consolidated current assets by
$6.9 million as of December 31, 2009, and $0.1 million as of December 31, 2008.
In addition, as of December 31, 2009 our capital commitment was $1.34 million
and will be settled within one year.
As of
December 31, 2009, our accounts and notes receivable (less allowance for
doubtful accounts of approximately $2.05 million) were approximately $12.1
million, an increase of approximately $3 million, from $9.1 million (net of
allowance for doubtful accounts of $4.8 million) as of December 31, 2008. The
increase of notes and accounts receivables is attributed primarily to the
increasing sales.
Before
2009, we made significant cash advances to our sales representatives to assist
and encourage them to expand the marketing and sales of our products into new
markets and to develop new customers. We believed that the sales representatives
would be better able to expand into new markets and to secure new customers if
they were advanced funds for their travel, meals and other incidental expenses
that arose in connection with their sales activities. Prior to September 2006,
we did not ask sales representatives to pay off advances immediately because the
Chinese economy has grown quickly and because competition in the pharmaceutical
industry is intense. Instead, we encouraged sales representatives to expand
their markets and gain more customers. However, beginning in September 2006, we
began to more vigorously pursue collection of all sales representative advances.
Nonetheless, there are some sales representative advances that have aged so
significantly that, based on prior experience, we do not expect to collect on
every outstanding advance and have estimated the uncollectible balance based on
the age of the advances. Pursuant to the policies adopted at the beginning of
2009, instead of advancing sales representatives money to sustain or develop
markets, we reimburse sales representatives their selling and marketing expenses
when they present expense vouchers. Management considers this a better way to
manage the potential for bad debts on the advances to sales representatives. We
pay the accrued selling expenses only when we collect an account receivable for
which a sales representative has presented his expense receipts. Because we
offer a grace period of one-to-six months to our clients for remitting payments
due, the accrued sales expenses may remain outstanding for however long it takes
to collect the corresponding accounts receivable.
Current
and long-term sales representatives and employee advances (net of allowances for
doubtful accounts) were approximately $6.37 million and $9.3 million as of
December 31, 2009 and 2008 respectively, a decrease of approximately $3 million.
The decrease was mainly due to other receivables amounting to $2.3 million,
which had been overdue for more than 2 years and for which a full allowance had
been provided for, were written off since they were deemed uncollectible after
we had implemented every possible collection procedures.
|
December 31,
|
|||||||
2009
|
2008
|
|||||||
Gross
amount of sales representative advances
|
$
|
8,025,300
|
$
|
12,921,134
|
||||
Allowance
for doubtful accounts
|
1,651,199
|
3,620,048
|
||||||
Net
amount
|
$
|
6,374,101
|
$
|
9,301,086
|
As of
December 31, 2009, our accounts payable were approximately $4.7 million, an
increase of $3.4 million, from $1.3 million as of December 31, 2008. The
increase of accounts payable is mainly attributed to construction of new
buildings.
Our
payment cycle is considerably shorter than our receivable cycle, since we
typically pay our suppliers all or a portion of the purchase price in advance
and for some suppliers we must maintain a deposit for future orders. We require
our sales representatives to pay a certain percentage of the sales price as
deposit before we ship products to the customers. The deposit were approximately
$7.1 million as of December 31, 2009, increased approximately $1.5 million, from
$5.6 million as of December 31, 2008, due to increasing sales
volume.
46
As
discussed above, in order
to develop a better channel for selling our products and to increase our revenue
in the fierce industry competition, we began to build relationships with high
quality agents, which required greater commissions, and therefore the other
payables and accrued expense increased by $7.4 million, from $2.7 million as of
December 31, 2008 to $ 10.1 million as of December 31, 2009.
To the
extent that we cannot satisfy our cash needs, whether from operations or from a
financing source, our business may be impaired in that it may be difficult for
us to obtain products which could, in turn, impair our ability to generate
sales. We have implemented new policies aimed at improving collection of
accounts receivable in the future, including more detailed reporting from and
increased control over provincial sales offices and representatives, incentives
for sales representatives more closely tied to timely collection and more
stringent enforcement of payment terms with wholesale companies.
On August
6, 2009, we obtained a one-year line of credit from Agricultural Bank of China
(“ABC”) amounting to RMB 110 million (approximately $16 million) based on ABC’s
assessment of our operations and unencumbered assets. As of December 31, 2009,
the balance from ABC amounted to RMB 57 million (approximately $8.3 million) and
the remaining unused line of credit was RMB 53 million (approximately
$7.7million), which requires additional collaterals. The Long-term borrowing
from ABC, amounting to USD1,462,587 ,which originally fell due on March 25,
2010, was renewed in February 2010 with a new maturity date of January 31,
2011
Further,
in July, 2009, we signed a factoring agreement with China Construction Bank (the
“CCB”) to transfer our accounts receivable with full recourse, and the proceeds
received from CCB being recognized as secured borrowings, with facility
amounting to RMB 18.5 million (approximately $2.7 million). Under this factoring
agreement we have drawn bank loans amounting approximately to RMB 11million
($1.65 million).
Considering
the financial resources presently available, we are confident that we have
sufficient working capital for our present requirements and for at least the
next 12 months; however, we may require additional capital for acquisitions, for
expanding business to related fields, or for the operation of the combined
companies and there is no assurance that such funding will be available. Please
see Note 8 –Borrowings in the Consolidated Financial Statements.
Off-Balance
Sheet Arrangements
None.
Foreign
Currency Risk
Since all
of our operations are conducted in the PRC, we are subject to special
considerations and significant risks not typically associated with companies
operating in the United States of America. These risks include, among others,
the political, economic and legal environments and foreign currency exchange
rate fluctuations. Our operational results may be adversely affected by changes
in the political and social conditions in the PRC, and by changes in
governmental policies with respect to medical reforms and other laws and
regulations, anti-inflationary measures, currency conversion and remittance
abroad, and rates and methods of taxation, among other things. Exchange rate
fluctuations may adversely affect the value, in U.S. dollar terms, of our net
assets and income derived from our operations in the PRC. In addition, all of
our revenue is denominated in the Chinese Yuan Renminbi (“RMB”), which must be
converted into other currencies before remittance out of the PRC. Both the
conversion of RMB into foreign currencies and the remittance of foreign
currencies abroad require approval of the PRC government. The effect of the
fluctuations of exchange rates is not considered to be material to our business
operations.
Interest
Rate Risk
We do not
have significant interest rate risk, as our debt obligations are primarily fixed
interest rates.
47
ITEM 7A.
|
QUANTITATIVE AND QUALITATIVE
DISCLOSURES ABOUT MARKET
RISK.
|
Smaller
reporting companies are not required to provide the information required by this
item.
ITEM 8.
|
FINANCIAL STATEMENTS AND
SUPPLEMENTARY DATA.
|
The
information required by this Item 8 is incorporated by reference to the
Consolidated Financial Statements beginning at page F-1 at the end of this Form
10-K.
ITEM 9.
|
CHANGES IN AND DISAGREEMENTS WITH
ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE.
|
As a
result of a competitive request for proposal, we decided to change our
independent registered public accounting firm from Hansen, Barnett &
Maxwell, P.C. (“HBM”) to B&P, an Independent Member of the BDO Seidman
Alliance with offices in New York City, Beijing and Guangzhou. On August 26,
2009, as previously recommended by the Audit Committee and as authorized by the
Board of Directors, we signed an engagement letter with B&P to serve as our
independent registered public accounting firm and to review our financial
statements for the period ended September 30, 2009 and audit our financial
statements for the year ended December 31, 2009. This action effectively
dismissed HBM on August 26, 2009 as our independent registered public accounting
firm.
The
reports of HBM on the financial statements of the Company for the years ended
December 31, 2008 and 2007 contained no adverse opinion or disclaimer of opinion
and were not qualified or modified as to uncertainty, audit scope or accounting
principles, with the exception of the separate paragraph in the independent
audit report by HBM for the fiscal year ended December 31, 2007
stating:
“As
discussed in Note 1, to the accompanying consolidated financial statements, the
Company has restated the accompanying 2007 consolidated financial
statements.”
The
inclusion of this statement in the independent audit report was the result of an
internal investigation conducted by the Company as previously disclosed on Form
8-K filed with the Securities and Exchange Commission (the “Commission”) on
August 22, 2008 and on Form 8-K/A filed with the Commission on September 12,
2008.
During
the Company’s two fiscal years ended December 31, 2008 and 2007 and the
subsequent interim period through August 26, 2009, there have been no
disagreements with HBM on any matter of accounting principles or practices,
financial statement disclosures, or auditing scope or procedures, which
disagreements if not resolved to the satisfaction of HBM would have caused it to
make reference to the subject matter of such disagreements in connection with
its reports on the financial statements for such years and any interim
periods.
During
the fiscal years ended December 31, 2008 and 2007 and the subsequent interim
period through August 26, 2009, neither the Company, nor anyone acting on its
behalf, consulted with B&P with respect to the application of accounting
principles to a specified transaction, either completed or proposed, or the type
of audit opinion that would have been rendered on the Company’s consolidated
financial statements, or any matters that were either the subject of a
disagreement (as that term is used in Item 304(a)(1)(iv) of Regulation S-K and
the related instructions to Item 304 of Regulation S-K) or a reportable event
(as described in Item 304(a)(1)(v) of Regulation S-K).
48
ITEM 9A.
|
CONTROLS AND
PROCEDURES.
|
Report
of Independent Registered Public Accounting Firm
To the
Board of Directors and Stockholders of
China
Shenghuo Pharmaceutical Holdings, Inc
We have
audited China Shenghuo Pharmaceutical Holdings, Inc. and Subsidiaries’ (“the
Company”) internal control over financial reporting as of December 31, 2009,
based on criteria established in Internal Control—Integrated
Framework issued by the Committee of Sponsoring Organizations of the
Treadway Commission (COSO). The Company’s management is responsible for
maintaining effective internal control over financial reporting and for its
assessment of the effectiveness of internal control over financial reporting,
included in the accompanying Management’s Report on Internal Control over
Financial Reporting. Our responsibility is to express an opinion on the
company’s internal control over financial reporting based on our
audit.
We
conducted our audit 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 effective
internal control over financial reporting was maintained in all material
respects. Our audit of internal control over financial reporting included
obtaining an understanding of internal control over financial reporting,
assessing the risk that a material weakness exists, and testing and evaluating
the design and operating effectiveness of internal control based on the assessed
risk. Our audit also included performing such other procedures as we considered
necessary in the circumstances. We believe that our audit provides a reasonable
basis for our opinion.
A
company’s internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. A company’s internal control over
financial reporting includes those policies and procedures that (1) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (2)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the company’s
assets that could have a material effect on the financial
statements.
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 or procedures may deteriorate.
A
material weakness is a control deficiency, or combination of deficiencies, in
internal control over financial reporting, such that there is a reasonable
possibility that a material misstatement of the Company’s annual or interim
financial statements will not be prevented or detected on a timely basis.
Material weakness has been identified and included in management’s assessment in
the area of entity-level controls (U.S. GAAP reporting expertise). This material
weakness was considered in determining the nature, timing, and extent of audit
tests applied in our audit of the 2009 financial statements, and this report
does not affect our report dated April 14, 2010 on those financial
statements.
In our
opinion, because of the effect of the material weakness described above on the
achievement of the objectives of the control criteria, the Company has not
maintained effective internal control over financial reporting as of December
31, 2009, based on criteria established in Internal Control—Integrated
Framework issued by the Committee of Sponsoring Organizations of the
Treadway Commission (COSO).
We have
also audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), the consolidated balance sheet and the related
consolidated statement of operations and comprehensive loss, changes in equity,
and cash flows of the Company, and our report April 14, 2010 expressed an
unqualified opinion.
/s/
Bernstein & Pinchuk LLP
|
|
New
York, NY
|
|
April
14, 2010
|
Evaluation
of disclosure controls and procedures
Our
management, with the participation of our chief executive officer and chief
financial officer, Messrs. Gui Hua Lan and Mr. Chuanxiang Huang respectively,
evaluated the effectiveness of our disclosure controls and procedures. The term
“disclosure controls and procedures,” as defined in Rules 13a-15(e) and
15d-15(e) under the Exchange Act, means controls and other procedures of a
company that are designed to ensure that information required to be disclosed by
a company in the reports, such as this report, that it files or submits under
the Exchange Act is recorded, processed, summarized and reported, within the
time periods specified in the SEC’s rules and forms. Disclosure controls and
procedures include, without limitation, controls and procedures designed to
ensure that information required to be disclosed by a company in the reports
that it files or submits under the Exchange Act is accumulated and communicated
to the Company’s management, including its principal executive and principal
financial officers, as appropriate to allow timely decisions regarding required
disclosure. Management recognizes that any controls and procedures, no matter
how well designed and operated, can provide only reasonable assurance of
achieving their objectives and management necessarily applies its judgment in
evaluating the cost-benefit relationship of possible controls and procedures.
Based on that evaluation, Mr. Lan and Mr. Huang concluded that despite
improvements in areas of previously identified weakness in internal control over
financial reporting identified (described below), our disclosure controls and
procedures were not effective as of December 31, 2009.
Management’s
Report on Internal Control over Financial Reporting
Our
management is responsible for establishing and maintaining adequate internal
control over financial reporting, as such term is defined in Exchange Act Rules
13a-15(f) and 15d-15(f). Internal control over financial reporting refers to the
process designed by, or under the supervision of, our principal executive
officer and principal financial officer, and effected by our Board of Directors,
management and other personnel, to provide reasonable assurance regarding the
reliability of financial reporting and the preparation of financial statements
for external purposes in accordance with generally accepted accounting
principles, and includes those policies and procedures that:
(1)
Pertain to the maintenance of records that in reasonable detail accurately and
fairly reflect the transactions and dispositions of our assets;
(2)
Provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that our receipts and expenditures are being made
only in accordance with authorization of our management and directors;
and
(3)
Provide reasonable assurance regarding prevention or timely detection of
unauthorized acquisitions, use or disposition of our assets that could have a
material effect on the financial statements.
49
Internal
control over financial reporting cannot provide absolute assurance of achieving
financial reporting objectives because of its inherent limitations. Internal
control over financial reporting is a process that involves human diligence and
compliance and is subject to lapses in judgment and breakdowns resulting from
human failures. Internal control over financial reporting also can be
circumvented by collusion or improper management override. Because of such
limitations, there is a risk that material misstatements may not be prevented or
detected on a timely basis by internal control over financial reporting.
However, these inherent limitations are known features of the financial
reporting process. Therefore, it is possible to design into the process
safeguards to reduce, though not eliminate, this risk. Management is responsible
for establishing and maintaining adequate internal control over financial
reporting for the company.
As of
December 31, 2009, our management conducted an assessment of the
effectiveness of our internal control over financial reporting, based on the
framework established in Internal Control — Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission, or COSO. Based
on this assessment, our management has concluded that our Company’s internal
control over financial reporting as of December 31, 2009 was ineffective
due to the following material weakness:
Lack of U.S. GAAP
expertise - Despite
substantial efforts to improve the Company’s controls and procedures, as
previously reported by the Company, our current accounting staff is relatively
new and inexperienced, and needs substantial additional training to meet the
higher demands of being qualified accountants of a U.S. public company. The
accounting skills and understanding necessary to fulfill the requirements of
U.S. GAAP-based reporting, including the skills of U.S. GAAP-based period end
closing, consolidation of financial statements, and U.S. GAAP
conversion, are inadequate and were inadequately supervised. The lack of
adequate U.S. GAAP review resulted in some material audit adjustments for the
year ended December 31, 2009, which were made to eliminate intercompany
transactions, adjust taxes payable for tax provision, adjust deferred tax, and
record prior year audit adjustments to adjust the allowance for doubtful
accounts.
Our
management has identified the following steps to address the above material
weakness:
(1) Since
January 1, 2009, we have maintained a separate set of accounting data to record
all U.S. GAAP audit adjustments from 2008 along with the PRC accounting records
so as to effectively reconcile PRC accounts to the financial statements under
U.S. GAAP.
(2) Since
October 2009, we have engaged Essence Consulting and Management Ltd, an outside
professional firm to aid in financial reporting procedures and to help with the
preparation of the Company’s annual and quarterly filings.
(3) We
will hire, as needed, key accounting personnel with technical accounting
expertise and reorganize the finance department to ensure that accounting
personnel with adequate experience, skills and knowledge relating to complex,
non-routine transactions are directly involved in the review and accounting
evaluation of our complex, non-routine transactions.
(4) We
will employ, as needed, outside professionals to provide key accounting
personnel ongoing technical trainings to ensure their proper understanding of
newly announced accounting standards.
We
believe the effective implementation of the above remedial actions will require
time and continuous monitoring. As some of the above initiatives were
implemented late in the fiscal year ended December 31, 2009, there was
insufficient time to integrate the additional resources into our financial
reporting processes and overcome the material weaknesses as of December 31,
2009. Accordingly, we continue to believe there is a material weakness relating
to the insufficient integration of our personnel with U.S. GAAP expertise into
the financial reporting process, resulting in inadequate processes and
documentation to address accounting and reporting requirements under U.S.
GAAP.
Our
management is not aware that the material weakness in our internal control over
financial reporting causes them to believe that any material inaccuracies or
errors existed in our financial statement as of December 31, 2009.
The
effectiveness of our internal control over financial reporting as of
December 31, 2009, has been audited by Bernstein & Pinchuk LLP, an
independent registered public accounting firm, as stated in their report
appearing on page 49.
Changes
in Internal Control over Financial Reporting
The
Company has continuously refined the policies and standards for the control
environment based on the risk control framework established in the Internal
Control Integrated Framework issued by the COSO. In the past few months, the
Company has: standardized control procedures for monitoring the financial
reporting and period end financial closing procedures at the subsidiary and
group level and upgraded the business performance review processes and controls;
expanded accounting manuals to clearly document key controls and processes for
preparing consolidated financial statements in accordance with applicable
accounting standards; hired outside accounting professionals with experience in
financial reporting and familiarity with U.S. GAAP-based accounting practices
and increased technical training for the finance and accounting personnel in
respect of relevant accounting standards; established and implemented the code
of ethics for senior officers and employees, company-wide anti-fraud policies
and whistle blowing mechanisms.
In the
past 5 months, the CEO and CFO have evaluated several changes to our internal
control over financial reporting as of December 31, 2009 that had materially
affected our internal control over financial reporting, and based on that
evaluation, the management has concluded that the following prior year material
weakness and significant deficiencies have been remediated:
· Capital
expenditures were discussed and approved at management meetings at which some of
the board of directors attended but no formal board procedures were followed,
which was a significant deficiency in our internal controls.
50
· Sales
department and warehouse department failed to follow the policy of returned
goods to timely handle the returned goods from customers, which was a material
weakness. This weakness relating to the failure to follow Company’s
returned goods policy was based primarily on the lack of clarity among the
Company’s financial personnel as to their respective assignments and duties with
respect to the Company’s returned goods policy. As a result, there was a
breakdown in communication between the warehousing and financial departments,
and no person made an accounting of returned goods when those goods were
returned by customers.
· The
duties of the cashiers in our financial department were not properly segregated,
which was a significant deficiency in our internal controls.
Remediation
· In
January of 2009, we developed a policy to require board of directors’ written
resolutions to approve all important capital expenditures.
· Beginning
in March of 2009, we started to improve the returned goods policy and the
controls with respect to that policy by instructing and training our financial
staff, through meetings and communications, of their individual duties with
respect to the Company’s accounting policies, including the returned goods
policy, in order to ensure that all returned goods are properly accounted
for. The Company has finished the process of formally documenting the
returned goods policy.
· Beginning
in March of 2009, we started to implement adequate segregation of duties in
financial function, which has separated duties of accessing to property and
assets from preparing or recording accounts. We have informed the
financial staff, through meetings and communications, of their individual duties
and each has been properly instructed and trained with respect to the Company’s
accounting policies. The Company has finished the process of documenting its
various policies.
We believe that the foregoing steps
have helped us remediate the above material weakness and significant
deficiencies identified in prior year assessment and we will continue to monitor
the effectiveness of these steps and make any changes that our management deems
appropriate.
ITEM
9B. OTHER INFORMATION.
None.
51
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.
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 ACCOUNTING FEES AND
SERVICES.
|
The
information required by this Item is incorporated by reference to the applicable
information in the 2010 Proxy Statement.
52
PART
IV
ITEM15.
|
EXHIBITS, FINANCIAL STATEMENT
SCHEDULES.
|
Exhibit
Number
|
|
Description of Exhibit
|
2.1
|
Share
Exchange Agreement, dated as of June 30, 2006, by and among the Company,
Kunming Shenghuo Pharmaceutical (Group) Co., Ltd., and Lan’s International
Medicine Investment Co., Limited (incorporated by referenced from Exhibit
2.1 to the Quarterly Report on Form 10-QSB filed with the Securities and
Exchange Commission on July 28, 2006).
|
|
2.1(a)
|
Amendment
No. 1 to the Share Exchange Agreement, dated as of August 11, 2006, by and
among the Company, Kunming Shenghuo Pharmaceutical (Group) Co., Ltd., and
Lan’s International Medicine Investment Co., Limited (incorporated by
reference from Exhibit 2.1(a) to the Registration Statement on Form SB-2
filed with the Securities and Exchange Commission on December 21,
2006).
|
|
2.1(b)
|
Amendment
No. 2 to the Share Exchange Agreement, dated as of August 28, 2006, by and
among the Company, Kunming Shenghuo Pharmaceutical (Group) Co., Ltd., and
Lan’s International Medicine Investment Co., Limited (incorporated by
reference from Exhibit 2.1(b) to Current Report on Form 8-K filed with the
Securities and Exchange Commission on September 1,
2006).
|
|
3.1
|
Certificate
of Incorporation of the Company (incorporated by reference from Exhibit
3.1 to Registration Statement on Form 10-SB filed with the Securities and
Exchange Commission on August 3, 2005).
|
|
3.2
|
Bylaws
of the Company (incorporated by reference from Exhibit 3.2 to Registration
Statement on Form 10-SB filed with the Securities and Exchange Commission
on August 3, 2005, and incorporated herein by
reference).
|
|
3.3
|
Articles
of Merger Effecting Name Change (incorporated by reference from Exhibit
3.3 to Current Report on Form 8-K filed with the Securities and Exchange
Commission on September 1, 2006).
|
|
10.1
|
Form
of Subscription Agreement dated August 31, 2006 (incorporated by reference
from Exhibit 10.1 to Current Report on Form 8-K filed with the Securities
and Exchange Commission on September 1, 2006).
|
|
10.2*
|
Employment
Agreement dated December 3, 2004 by and between Gui Hua Lan and the
Company (translated to English) (incorporated by reference from Exhibit
10.2 to Current Report on Form 8-K filed with the Securities and Exchange
Commission on September 1, 2006).
|
|
10.3*
|
Employment
Agreement dated December 3, 2004 by and between Feng Lan and the Company
(translated to English) (incorporated by reference from Exhibit 10.3 to
Current Report on Form 8-K filed with the Securities and Exchange
Commission on September 1, 2006).
|
|
10.4*
|
Employment
Agreement dated December 3, 2004 by and between Lei Lan and the Company
(translated to English) (incorporated by reference from Exhibit 10.4 to
Current Report on Form 8-K filed with the Securities and Exchange
Commission on September 1, 2006).
|
|
10.5*
|
Employment
Agreement dated December 3, 2004 by and between Qiong Hua Gao and the
Company (translated to English) (incorporated by reference from Exhibit
10.5 to Current Report on Form 8-K filed with the Securities and Exchange
Commission on September 1, 2006).
|
|
10.6*
|
Employment
Agreement dated December 3, 2004 by and between Peng Chen and the Company
(translated to English) (incorporated by reference from Exhibit 10.6 to
Current Report on Form 8-K filed with the Securities and Exchange
Commission on September 1,
2006).
|
53
10.7*
|
Employment
Agreement dated December 3, 2004 by and between Zheng Yi Wang and the
Company (translated to English) (incorporated by reference from Exhibit
10.7 to Current Report on Form 8-K filed with the Securities and Exchange
Commission on September 1, 2006).
|
|
10.8
|
Joint
Establishment Agreement of Kunming Beisheng Science & Technology
Development Co., Ltd. dated January 1, 2006 entered into by and between
the Company and Beijing University Shijia Research Center (translated to
English) (incorporated by reference from Exhibit 10.8 to the Registration
Statement on Form SB-2 filed with the Securities and Exchange Commission
on December 21, 2006).
|
|
Joint
Venture Agreement for Kunming Shenghuo Pharmaceutical Group Co., Ltd.
dated May 22, 2006 entered into by and between Lan’s International
Medicine Investment Co., Limited and SDIC Venture Capital Investment, Co.,
Ltd. (translated to English) (incorporated by reference from Exhibit 10.9
to the Registration Statement on Form SB-2 filed with the Securities and
Exchange Commission on December 21, 2006).
|
||
10.10*
|
Form
of Independent Director’s Agreement, entered into by the Company with each
of Mingyang Liao, Yunhong Guan, Jason Zhang and Xiaobo
Sun (incorporated by reference from Exhibit 10.1 to the Current
Report on Form 8-K filed with the Securities and Exchange Commission on
September 26, 2007).
|
|
10.11*
|
Form
of Warrant Agreement, entered into by the Company with each of Gene
Michael Bennett and Yunhong Guan (incorporated by reference from Exhibit
10.2 to the Current Report on Form 8-K filed with the Securities and
Exchange Commission on September 26, 2007).
|
|
10.12
|
Form
of Warrant to be issued to be issued to the Underwriter, entered into by
the Company and Westpark Capital Inc. (incorporated by reference from
Exhibit 4.1 to the Registration Statement on Form SB-2 filed with the
Securities and Exchange Commission on June 11, 2007).
|
|
10.13
|
Line
of Credit Agreement dated August 6, 2009 by and between Kunming Shenghuo
Pharmaceutical (Group) Co., Ltd. and the Agricultural Bank of China
Limited Inc. (incorporated by reference from Exhibit 10.1 to the Quarterly
Report on Form 10-Q filed with the Securities and Exchange Commission on
November 16, 2009.)
|
|
10.14
|
Pledge
Agreement dated August 21, 2009 by and between the Company and
Agricultural Bank of China Shuanglong Branch. (incorporated by reference
from Exhibit 10.2 to the Quarterly Report on Form 10-Q filed with the
Securities and Exchange Commission on November 16,
2009.)
|
|
10.15
|
Insurance
Policy dated May 4, 2009 issued by Ping An Property & Casualty
Insurance Company of China, Ltd. in favor of the Company. (incorporated by
reference from Exhibit 10.3 to the Quarterly Report on Form 10-Q filed
with the Securities and Exchange Commission on November 16,
2009.)
|
|
10.16
|
Indemnity
Agreement dated June 9, 2009 by and among the Company, Ping An Property
& Casualty Insurance Company of China, Ltd. and China Construction
Bank Kunming Heping Branch. (incorporated by reference from Exhibit 10.4
to the Quarterly Report on Form 10-Q filed with the Securities and
Exchange Commission on November 16, 2009.)
|
|
10.17
|
Loan
Contract dated August 24, 2009 by and between Kunming Shenghuo
Pharmaceutical (Group) Co., Ltd. and the Agricultural Bank of China
Limited Inc.
|
|
10.18
|
Loan
Contract dated March 26, 2008 by and between Kunming Shenghuo
Pharmaceutical (Group) Co., Ltd. and the Agricultural Bank of China
Limited Inc.
|
|
10.19
|
Rights
Pledge Contract dated August 19, 2009 by and between the Company and the
Agricultural Bank of China Limited
Inc.
|
54
10.20
|
Mortgage
Contract dated March, 2008 by and between Kunming Shenghuo Pharmaceutical
(Group) Co., Ltd. and the Agricultural Bank of China Limited
Inc.
|
|
10.21
|
Loan
Contract dated March 30, 2007 by and between Kunming Shenghuo
Pharmaceutical (Group) Co., Ltd. and China Construction Bank, Kunming
Heping Branch.
|
|
10.22
|
Mortgage
Contract dated March 30 , 2007 by and between Kunming Shenghuo
Pharmaceutical (group) Co., Ltd. and China Construction Bank, Kunming
Heping Branch.
|
|
10.23
|
Borrowing
Contract dated March 29, 2010 by and between Kunming Shenghuo
Pharmaceutical (Group) Co., Ltd. and Kunming Municipal Bureau of Finance,
Branch Bureau of Kunming National Economy and Technology Developing
District.
|
|
10.24
|
Loan
Contract dated January, 2010 by and between Kunming Shenghuo
Pharmaceutical (Group) Co., Ltd. and the Agricultural Bank of China
Limited Inc.
|
|
10.25
|
Mortgage
Contract dated January, 2010 by and between Kunming Shenghuo
Pharmaceutical (Group) Co., Ltd. and the Agricultural Bank of China
Limited Inc.
|
|
10.26
|
Stock
Warrant Purchase Agreement, entered into by the Company with CCG Investor
Relations Partners LLC, dated April 20, 2007.
|
|
10.27
|
Loan
Contract dated April 7, 2010 by and between Kunming Shenghuo
Pharmaceutical (Group) Co., Ltd. and the Agricultural Bank of China
Limited Inc.
|
|
10.28
|
Mortgage
Contract dated March 31, 2010 by and between Kunming Shenghuo
Pharmaceutical (Group) Co., Ltd. and the Agricultural Bank of China
Limited Inc., Kunming Shuanglong Sub-Branch.
|
|
10.29
|
Mortgage
Contract dated March 31, 2010 by and between Kunming Shenghuo
Pharmaceutical (Group) Co., Ltd. and the Agricultural Bank of China
Limited Inc., Kunming Shuanglong Sub-Branch.
|
|
14.1**
|
China
Shenghuo Pharmaceutical Holdings, Inc. Code of Business Conduct and Ethics
(incorporated by reference from Exhibit 99.1 to the Current Report on Form
8-K filed with the Securities and Exchange Commission on June 12,
2007).
|
|
16.1
|
Letter
from Hansen, Barnett & Maxwell, P.C. dated August 26, 2009
(incorporated by reference from Exhibit 16.1 to the Current Report on Form
8-K filed with the Securities and Exchange Commission on August 26,
2009.)
|
|
21.1
|
List
of Subsidiaries (incorporated by reference from Exhibit 21.1 to the
Registration Statement on Form SB-2 on Form S-3 filed with the Securities
and Exchange Commission on September 18, 2007).
|
|
31.1
|
Rule
13a-14(a) Certification of the Chief Executive Officer of China Shenghuo
Pharmaceutical Holdings, Inc. in accordance with Section 302 of the
Sarbanes-Oxley Act of 2002.
|
|
31.2
|
Rule
13a-14(a) Certification of the Chief Financial Officer of China Shenghuo
Pharmaceutical Holdings, Inc. in accordance with Section 302 of the
Sarbanes-Oxley Act of 2002.
|
|
32.1*
*
|
Section
1350 Certification of the Chief Executive Officer and Chief Financial
Officer of China Shenghuo Pharmaceutical Holdings, Inc. in accordance with
Section 906 of the Sarbanes-Oxley Act of
2002.
|
55
*
|
Indicates management contract or
compensatory plan or
arrangement.
|
**
|
This exhibit shall not be deemed
“filed” for purposes of Section 18 of the Securities Exchange Act of
1934, as amended, or otherwise subject to the liabilities of that Section,
nor shall it be deemed incorporated by reference in any filing under the
Securities Act of 1933, as amended, or the Securities Exchange Act of
1934, as amended, whether made before or after the date hereof and
irrespective of any general incorporation language in any
filings.
|
56
In
accordance with Section 13 or 15(d) of the Securities Exchange Act of 1934, the
registrant caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.
CHINA SHENGHUO
PHARMACEUTICAL HOLDINGS,
INC.
(Company)
|
||
April
14, 2010
|
By:
|
/s/ Gui Hua Lan
|
Gui
Hua Lan
|
||
Chief
Executive Officer and Chairman of the
Board
|
In
accordance with the Securities Exchange Act of 1934, this report has been
signed below by the following persons on behalf of the registrant and in the
capacities and on the dates indicated.
/s/ Gui Hua Lan
|
||
Date:
April 14, 2010
|
Gui
Hua Lan, Chief Executive Officer and
Chairman
of the Board
(Principal
Executive Officer)
|
|
/s/ Chuanxiang Huang
|
||
Date:
April 14, 2010
|
Chuanxiang
Huang, Chief Financial Officer
(Principal
Financial and Accounting Officer)
|
|
/s/ Feng Lan
|
||
Date:
April 14, 2010
|
Feng
Lan, President and Director
|
|
/s/ Xiao He
|
||
Date:
April 14, 2010
|
Xiao
He, Director
|
|
/s/ Yunhong Guan
|
||
Date:
April 14, 2010
|
Yunhong
Guan, Director
|
|
/s/ Jason Yuanxin Zhang
|
||
Date:
April 14, 2010
|
Jason
Yuanxin Zhang, Director
|
|
/s/ Xiaobo Sun
|
||
Date:
April 14, 2010
|
Xiaobo
Sun, Director
|
CHINA
SHENGHUO PHARMACEUTICAL HOLDINGS, INC.
AND
SUBSIDIARIES
CONSOLIDATED
FINANCIAL STATEMENTS
DECEMBER
31, 2009 AND 2008
TABLE
OF CONTENTS
Reports
of Independent Registered Public Accounting Firm
|
F-1
~ F-2
|
|
Consoli Consolidated
Balance Sheets
|
F-3
|
|
Consoli Consolidated
Statements of Operations and Comprehensive Loss
|
F-5
|
|
Consol Consolidated
Statements of Changes in Equity
|
F-6
|
|
Consoli Consolidated
Statements of Cash Flows
|
F-7
|
|
Notes
to Notes to the Consolidated Financial Statements
|
F-8
~ F-23
|
Report of Independent
Registered Public Accounting Firm
To the
Board of Directors and Stockholders of
China
Shenghuo Pharmaceutical Holdings, Inc
We have
audited the accompanying consolidated balance sheet of China Shenghuo
Pharmaceutical Holdings, Inc. and Subsidiaries (“the Company”) as of December
31, 2009, and the related consolidated statement of operations and comprehensive
loss, changes in equity, and cash flows for the year ended December 31, 2009.
The Company’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. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes 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 financial statements referred to above present fairly, in all
material respects, the financial position of the Company as of December 31,
2009, and the results of its operations and its cash flows for the year ended
December 31, 2009 in conformity with accounting principles generally accepted in
the United States of America.
We also
have audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), the Company’s internal control over financial
reporting as of December 31, 2009, based on criteria established in Internal
Control—Integrated Framework issued by the Committee of Sponsoring Organizations
of the Treadway Commission (COSO), and our report dated April 14, 2010 expressed
an adverse opinion.
/s/
Bernstein & Pinchuk LLP
|
|
New
York, NY
|
|
April
14, 2010
|
F-1
A
Professional Corporation
CERTIFIED
PUBLIC ACCOUNTANTS
5
Triad Center, Suite 750
Salt
Lake City, UT 84180-1128
Phone:
(801) 532-2200
Fax:
(801) 532-7944
www.hbmcpas.com
|
Registered
with the Public Company
Accounting
Oversight Board
|
REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the
Board of Directors and
Stockholders
of China Shenghuo Pharmaceutical Holdings, Inc.
We have
audited the accompanying consolidated balance sheet of China Shenghuo
Pharmacetical Holdings, Inc. and subsidiaries (the Company) as of December 31,
2008, and the related consolidated statements of operations and comprehensive
loss, changes in equity, and cash flows for the year then ended. The Company’s
management is responsible for these financial statements. Our responsibility is
to express an opinion on these financial statements based on our
audit.
We
conducted our audit 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. Our audit of the financial
statements included 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, and evaluating the overall
financial statement presentation. Our audit also included performing such other
procedures as we considered necessary in the circumstances. We believe that our
audit provides 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 Shenghuo Pharmacetical
Holdings, Inc. and subsidiaries as of December 31, 2008, and the results of
their operations and their cash flows for the year then ended in conformity with
accounting principles generally accepted in the United States of
America.
HANSEN, BARNETT & MAXWELL, P.C. |
Salt Lake City, Utah
March 31, 2009 except for Note 2 (x) regarding
the retrospective application of noncontrolling interests in consolidated
financial statements,
as to which the date is April 14,
2010.
F-2
CHINA SHENGHUO PHARMACEUTICAL
HOLDINGS, INC.
AND
SUBSIDIARIES
CONSOLIDATED
BALANCE SHEETS
(Amounts
in USD, except shares)
December 31,
|
||||||||||||
Notes
|
2009
|
2008
|
||||||||||
Assets:
|
||||||||||||
Current
Assets:
|
||||||||||||
Cash
and cash equivalents
|
$ | 1,986,540 | $ | 1,612,054 | ||||||||
Accounts
and notes receivable, net
|
3
|
12,104,296 | 9,108,703 | |||||||||
Other
receivables, net
|
4
|
6,694,151 | 8,637,653 | |||||||||
Advances
to suppliers
|
394,856 | 446,168 | ||||||||||
Inventories,
net
|
5
|
3,896,358 | 4,287,462 | |||||||||
Due
from related parties
|
9
|
417,494 | - | |||||||||
Current
deferred tax assets
|
11
|
849,993 | - | |||||||||
Other
current assets
|
16,652 | 41,177 | ||||||||||
Total
Current Assets
|
26,360,340 | 24,133,217 | ||||||||||
Property,
plant and equipment, net
|
6
|
12,065,552 | 7,581,664 | |||||||||
Intangible
assets, net
|
7
|
1,127,224 | 665,959 | |||||||||
Long-term
other receivable, net
|
- | 663,433 | ||||||||||
Non-current
deferred tax assets
|
11
|
370,197 | - | |||||||||
$ | 39,923,313 | $ | 33,044,273 |
See notes
to consolidated financial statements
F-3
CHINA
SHENGHUO PHARMACEUTICAL HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED
BALANCE SHEETS (CONT’D)
(Amounts
in USD, except shares)
December 31,
|
||||||||||||
Notes
|
2009
|
2008
|
||||||||||
Liabilities
and Equity:
|
||||||||||||
Current
Liabilities:
|
||||||||||||
Accounts
payable
|
$ | 4,744,919 | $ | 1,293,460 | ||||||||
Other
payables and accrued expenses
|
10,099,497 | 2,721,082 | ||||||||||
Deposits
payable
|
7,037,155 | 5,550,502 | ||||||||||
Due
to related parties
|
- | 148,575 | ||||||||||
Short-term
borrowings
|
8
|
5,455,958 | 9,850,211 | |||||||||
Advances
from customers
|
916,362 | 222,609 | ||||||||||
Taxes
and related payables
|
11
|
1,094,331 | 1,236,574 | |||||||||
Current
portion of long-term borrowings
|
8
|
3,948,985 | 3,245,685 | |||||||||
Total
Current Liabilities
|
33,297,207 | 24,268,698 | ||||||||||
Long-term
borrowings
|
8
|
5,850,348 | 1,131,193 | |||||||||
39,147,555 | 25,399,891 | |||||||||||
Commitments
and Contingencies
|
13
|
|||||||||||
Equity:
|
||||||||||||
Common
stock, $0.0001 par value, 100,000,000 shares authorized and
19,679,400 shares outstanding
|
1,968 | 1,968 | ||||||||||
Additional
paid-in capital
|
6,193,927 | 6,193,927 | ||||||||||
Appropriated
retained earnings
|
147,023 | 147,023 | ||||||||||
Accumulated
deficit
|
(7,157,293 | ) | (603,572 | ) | ||||||||
Accumulated
other comprehensive income
|
1,589,047 | 1,656,812 | ||||||||||
Total
stockholder's equity
|
774,672 | 7,396,158 | ||||||||||
Noncontrolling
interest
|
1,086 | 248,224 | ||||||||||
Total
Equity
|
775,758 | 7,644,382 | ||||||||||
$ | 39,923,313 | $ | 33,044,273 |
See notes
to consolidated financial statements
F-4
CHINA
SHENGHUO PHARMACEUTICAL HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED
STATEMENTS OF OPERATIONS
AND
COMPREHENSIVE LOSS
(Amounts
in USD, except shares)
Notes
|
Years ended December 31,
|
|||||||||||
2009
|
2008
|
|||||||||||
Sales
|
$ | 36,001,915 | $ | 28,690,509 | ||||||||
Cost
of Goods Sold
|
9,887,969 | 7,693,635 | ||||||||||
Gross
Margin
|
26,113,946 | 20,996,874 | ||||||||||
Operating
Expenses:
|
||||||||||||
Selling
expenses
|
26,281,103 | 13,274,942 | ||||||||||
General
and administrative expenses
|
6,920,489 | 10,856,184 | ||||||||||
Research
and development expense
|
139,944 | 338,546 | ||||||||||
33,341,536 | 24,469,672 | |||||||||||
Loss
from Operations
|
(7,227,590 | ) | (3,472,798 | ) | ||||||||
Other
Income (Expenses):
|
||||||||||||
Interest
income
|
4,871 | 7,755 | ||||||||||
Income
from Research and Development
|
- | 408,500 | ||||||||||
Subsidy
income
|
343,850 | - | ||||||||||
Interest
expense
|
(933,505 | ) | (1,309,984 | ) | ||||||||
Other
income
|
54,916 | - | ||||||||||
Other
expenses
|
(93,777 | ) | (73,421 | ) | ||||||||
(623,645 | ) | (967,150 | ) | |||||||||
Loss
Before Income Tax
|
(7,851,235 | ) | (4,439,948 | ) | ||||||||
Income
tax benefit (expense)
|
11
|
1,053,980 | (438,279 | ) | ||||||||
Net
Loss
|
(6,797,255 | ) | (4,878,227 | ) | ||||||||
Net
loss attributable to noncontrolling interests
|
(243,534 | ) | (235,318 | ) | ||||||||
Net
Loss Attributable to Stockholders
|
$ | (6,553,721 | ) | $ | (4,642,909 | ) | ||||||
Comprehensive
Loss:
|
||||||||||||
Net
loss
|
(6,797,255 | ) | (4,878,227 | ) | ||||||||
Foreign
currency translation adjustment
|
(71,369 | ) | 727,169 | |||||||||
Comprehensive
Loss
|
$ | (6,868,624 | ) | $ | (4,151,058 | ) | ||||||
Comprehensive
loss attributable to noncontrolling interests
|
(247,138 | ) | (198,596 | ) | ||||||||
Comprehensive
Loss Attributable to Stockholders
|
(6,621,486 | ) | (3,952,462 | ) | ||||||||
Basic
and diluted loss per share
|
$ | (0.33 | ) | $ | (0.24 | ) | ||||||
Weighted-average
number of shares outstanding-basic and diluted
|
19,679,400 | 19,679,400 |
See notes
to consolidated financial statements
F-5
CHINA
SHENGHUO PHARMACEUTICAL HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED
STATEMENTS OF CHANGES IN EQUITY
(Amounts
in USD, except shares)
Stockholder’s Equity
|
||||||||||||||||||||||||||||||||
Additional
|
Appropriated
|
Retained
Earnings
|
Accumulated
Other
|
|||||||||||||||||||||||||||||
Common Stock
|
Paid-in
|
retained
|
(Accumulated
|
Comprehensive
|
Noncontrolling
|
|||||||||||||||||||||||||||
Shares
|
Amount
|
Capital
|
earnings
|
Deficit)
|
Income
|
Interest
|
Total equity
|
|||||||||||||||||||||||||
December
31, 2007
|
19,679,400 | $ | 1,968 | $ | 6,193,927 | $ | 147,023 | $ | 4,039,337 | $ | 929,643 | $ | 483,542 | $ | 11,795,440 | |||||||||||||||||
Net
loss for the year
|
- | - | - | - | (4,642,909 | ) | - | (235,318 | ) | (4,878,227 | ) | |||||||||||||||||||||
Foreign
currency translation adjustment
|
- | - | - | - | - | 727,169 | - | 727,169 | ||||||||||||||||||||||||
December
31, 2008
|
19,679,400 | 1,968 | 6,193,927 | 147,023 | (603,572 | ) | 1,656,812 | 248,224 | 7,644,382 | |||||||||||||||||||||||
Net
loss for the year
|
- | - | - | - | (6,553,721 | ) | - | (243,534 | ) | (6,797,255 | ) | |||||||||||||||||||||
Foreign
currency translation adjustment
|
- | - | - | - | - | (67,765 | ) | (3,604 | ) | (71,369 | ) | |||||||||||||||||||||
December
31, 2009
|
19,679,400 | $ | 1,968 | $ | 6,193,927 | $ | 147,023 | $ | (7,157,293 | ) | $ | 1,589,047 | $ | 1,086 | $ | 775,758 |
See notes
to consolidated financial statements
F-6
CHINA
SHENGHUO PHARMACEUTICAL HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED
STATEMENTS OF CASH FLOWS
(Amounts
in USD)
Years ended December 31,
|
||||||||
2009
|
2008
|
|||||||
Cash
Flows from Operating Activities:
|
||||||||
Net
loss
|
$ | (6,797,255 | ) | $ | (4,878,227 | ) | ||
Adjustments
to reconcile net loss to net cash provided by operating
activities:
|
||||||||
Deferred
income tax
|
(1,219,655 | ) | - | |||||
Depreciation
and amortization
|
776,985 | 821,574 | ||||||
Provision
and allowance
|
1,836,590 | 2,371,559 | ||||||
Change
in current assets and liabilities:
|
||||||||
Accounts
and notes receivable
|
(4,504,549 | ) | 755,997 | |||||
Other
receivables
|
2,272,123 | (943,163 | ) | |||||
Due
from/to related parties
|
(598,817 | ) | - | |||||
Advances
to suppliers
|
52,399 | 264,467 | ||||||
Inventories
|
423,745 | 112,744 | ||||||
Other
current assets
|
24,616 | 120,381 | ||||||
Accounts
payable
|
853,028 | 490,195 | ||||||
Other
payables and accrued expenses
|
7,360,102 | 604,557 | ||||||
Advances
from customers
|
692,896 | 93,839 | ||||||
Deposits
payable
|
1,472,207 | 1,814,192 | ||||||
Taxes
and related payables
|
(145,828 | ) | 319,086 | |||||
Net
Cash Provided by Operating Activities
|
2,498,587 | 1,947,201 | ||||||
Cash
Flows from Investing Activities:
|
||||||||
Purchase
of long-lived assets
|
(3,120,663 | ) | (304,426 | ) | ||||
Net
Cash Used in Investing Activities
|
(3,120,663 | ) | (304,426 | ) | ||||
Cash
Flows from Financing Activities:
|
||||||||
Due
to related parties
|
- | 78,588 | ||||||
Proceeds
from borrowings
|
21,901,038 | 5,745,269 | ||||||
Payments
on borrowings
|
(20,908,646 | ) | (8,833,351 | ) | ||||
Net
Cash Provided by (Used in) Financing Activities
|
992,392 | (3,009,494 | ) | |||||
Effect
of exchange rate changes on cash
|
4,170 | 178,132 | ||||||
Net
Increase (Decrease) in Cash and Cash Equivalents
|
374,486 | (1,188,587 | ) | |||||
Cash
and Cash Equivalents at Beginning of Year
|
1,612,054 | 2,800,641 | ||||||
Cash
and Cash Equivalents at End of Year
|
$ | 1,986,540 | $ | 1,612,054 | ||||
Supplemental
Information
|
||||||||
Cash
paid for interest
|
$ | 921,451 | $ | 1,232,257 | ||||
Cash
paid for income tax
|
$ | 594,197 | $ | - |
See notes
to consolidated financial statements
F-7
CHINA
SHENGHUO PHARMACEUTICAL HOLDINGS, INC. AND SUBSIDIARIES
Notes
to Consolidated Financial Statements
NOTE
1 – ORGANIZATION AND NATURE OF OPERATIONS
(a)
|
Nature
of Business
|
China
Shenghuo Pharmaceutical Holdings, Inc, (“CSPH”), incorporated in Delaware,
United States of America, through its subsidiaries (collectively the “Company”),
designs, develops, markets, sells and exports pharmaceutical, nutritional
supplements and cosmetic products mainly in the People’s Republic of China
(“PRC”). The Company also conducts research and development using the medicinal
herb Panax notoginseng, also known as Sanqi, Sanchi, or Tienchi, which is grown
in two provinces in the PRC. Sales from the cosmetic products represent less
than 10% of total sales of the Company.
(b)
|
Organization
|
The CSPH
owns a 94.95% equity interest in Kunming Shenghuo Pharmaceuticals Co., Ltd.
(“Shenghuo”). Shenghuo owns a 99% equity interest in Kunming Shenghuo Medicine
Co., Ltd. (“Medicine”), a 99% equity interest in Kunming Pharmaceutical
Importation and Exportation Co., Ltd. (“Import/Export”), a 98.18% interest in
Kunming Shenghuo Cosmetics Co., Ltd. (“Cosmetic”), and a 70% interest in Kunming
Beisheng Science and Technology Development Co., Ltd (“Beisheng”). On April 30,
2009, Shenghuo formed Shi Ling Shenghuo Co., Ltd. (“Shi Ling”) as a wholly owned
subsidiary. Shi Ling was formed for the purpose of purchasing or leasing land
suitable for cultivating the medicinal herb Panax notoginseng for use in the
production of the Company’s medicinal products. As of December 31, 2009, Shi Lin
had not started its operation. All other entities are formed in and operate
within the PRC.
NOTE
2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(a)
|
Basis
of presentation and consolidation
|
The
consolidated financial statements have been prepared in accordance with U.S.
generally accepted accounting principles (“U.S. GAAP”).
In
addition, the consolidated financial information has been prepared on the basis
that the Company will continue to operate throughout the next twelve months as a
going concern. The Company’s consolidated current liabilities
exceeded its consolidated current assets by approximate USD7 million as of
December 31, 2009, and USD0.1 million as of December 31, 2008. Based
on future projections of the Company’s cash inflows from operations, reasonable
estimate of revolving effect of deposits received, and the anticipated ability
of the Company to obtain continued bank financing to finance its continuing
operations, the management of the Company (“Management”), has prepared the
consolidated financial statements on a going concern basis.
The
consolidated financial statements include the financial statements of the CSPH
and its subsidiaries. All significant inter-company transactions and balances
have been eliminated in consolidation.
Noncontrolling
interests represents the ownership interests in the subsidiaries that are held
by owners other than the parent and is part of the equity of the consolidated
group. The noncontrolling interests are reported in the consolidated balance
sheets within equity, separately from the parent’s equity. Net income or loss
and comprehensive income or loss is attributed to the parent and the
noncontrolling interests. If losses attributable to the parent and the
noncontrolling interests in a subsidiary exceed their interests in the
subsidiary’s equity, the excess, and any further losses attributable to the
parent and the noncontrolling interests, is attributed to those
interests.
F-8
(b)
|
Use
of estimates
|
The
preparation of financial statements in conformity with U.S. GAAP requires
Management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates.
Significant
estimates based on Management's best estimates include: a) valuation allowance
for deferred tax assets based on estimated future taxable income as described in
note 11; b) financial effect of a class action lawsuit as described in note
13-(c); and c) allowance for doubtful receivables as described in note 3 and
note 4. The relevant amounts could be adjusted in the near term if
experience differs from current estimates.
(c)
|
Foreign
currency translation
|
CSPH’s
functional currency is the United States dollar (“USD”). The functional currency
of the CSPH’s subsidiaries in the PRC is Renminbi (“RMB”).
At the
date a foreign currency transaction is recognized, each asset, liability,
revenue, expense, gain, or loss arising from the transaction is measured
initially in the functional currency of the recording entity by use of the
exchange rate in effect at that date. The increase or decrease in expected
functional currency cash flows upon settlement of a transaction resulting from a
change in exchange rates between the functional currency and the currency in
which the transaction is denominated is recognized as foreign currency
transaction gain or loss that is included in determining net income for the
period in which the exchange rate changes. At each balance sheet date,
recorded balances that are denominated in a foreign currency are adjusted to
reflect the current exchange rate.
The
Company’s reporting currency is USD. Assets and liabilities of the PRC
subsidiaries are translated at the current exchange rate at the balance sheet
dates, and revenues and expenses are translated at the average exchange rates
during the reporting periods. Translation adjustments are reported in other
comprehensive income.
(d)
|
Cash
and cash equivalents
|
Cash
includes not only currency on hand but demand deposits with banks or other
financial institutions. Cash equivalents are short-term, highly liquid
investments with original maturities of three months or less that are readily
convertible to cash.
(e)
|
Accounts
and notes receivable
|
Accounts
receivable are recognized and carried at original sale amounts less an allowance
for uncollectible accounts, as needed.
Accounts
receivable are reviewed periodically as to whether they are past due based on
contractual terms and their carrying values have become impaired. An allowance
for doubtful accounts is recorded in the period in which loss is determined to
be probable based on an assessment of specific evidence indicating doubtful
collection, historical experience, account balance aging and prevailing economic
conditions. Accounts receivable balances are written off after all collection
efforts have been exhausted.
Notes
receivable represent bankers’ acceptances that have been arranged with
third-party financial institutions by certain customers to settle their
purchases from us. These bankers’ acceptances are non-interest bearing and are
collectible within six months. Such sales and purchasing arrangements are
consistent with industry practices in the PRC.
There are
no outstanding amounts from customers that individually represent greater than
10% of the total balance of accounts receivable for the years
presented.
F-9
The
Company entered into a factoring agreement with China Construction
Bank (“CCB”), to transfer accounts receivable with full recourse. The
Company is required to repurchase the transferred accounts receivable, if any
controversy arises on the accounts receivable, at a price of proceeds received
from CCB less settled accounts receivable plus interest and other necessary
penalty or expense. The Company accounts for its transferred accounts
receivable in accordance with Statement of Financial Accounting Standard
(“SFAS”) No. 166, “Accounting for Transfers of Financial Assets” (“ASC Topic
810”), with the proceeds received from CCB being recognized as secured
borrowings (note 8 (a)).
(f)
|
Other
receivables
|
Other
receivables are presented at cost net of allowance for doubtful accounts. Other
receivables include sales representative advances for market development,
employee advances and sales office advances for facilities of sales activities.
As time passes from when advances are made to sales representatives for travel
and related expenses, the Company provides allowance for these older receivables
based on review of collectability risk from each particular sales representative
and aging of the ending balance. Other receivables balances are written off
after all collection efforts have been exhausted.
(g)
|
Inventories
|
Inventories
are stated at lower of cost or market.
Cost is determined using weighted average
method. Inventory embraces raw materials, work in process and finished
goods. The variable production overheads are allocated to each unit of
production on the basis of the actual use of the production facilities. The
allocation of fixed production overheads to the costs of conversion is based on
the normal capacity of the production facilities.
Where
there is evidence that the utility of inventories, in their disposal in the
ordinary course of business, will be less than cost, whether due to physical
deterioration, obsolescence, changes in price levels, or other causes, a
provision is accrued for the difference with charges to cost of
sales.
(h)
|
Property,
plant and equipment
|
Property,
plant and equipment are stated at historical cost less accumulated depreciation
and impairment. The historical cost of acquiring an item of property,
plant and equipment includes the costs necessarily incurred to bring it to the
condition and location necessary for its intended use. If an item of property,
plant and equipment requires a period of time in which to carry out the
activities necessary to bring it to that condition and location, the interest
cost incurred during that period as a result of expenditures for the item is a
part of the historical cost. This item is categorized as construction in
progress and is not depreciated until substantially all the activities necessary
to bring it to the condition and location necessary for its intended use are
completed.
Depreciation
of property, plant and equipment is calculated using the straight-line method
(after taking into account their respective estimated residual values) over the
estimated useful lives of the assets as follows.
Asset
|
Useful life (years)
|
Residual value %
|
||||
Buildings
|
25 - 30 | 3% | ||||
Machinery
|
3 - 20 | 0-5% | ||||
Office
equipment and furnishing
|
3 - 10 | 0-5% | ||||
Vehicles
|
3 - 10 | 0-5% |
Depreciation
of property, plant and equipment attributable to manufacturing activities is
capitalized as part of inventories, and expensed to cost of goods sold when
inventories are sold.
F-10
Expenditure
for maintenance and repairs is expensed as incurred.
The gain
or loss on the disposal of property, plant and equipment is the difference
between the net sales proceeds and the carrying amount of the relevant assets
and is recognized in the consolidated statements of operations.
(i)
|
Intangible
assets
|
The
Company’s intangible assets mainly consist of land use rights. According to the
laws of the PRC, the government owns all the land in the PRC. Companies or
individuals are authorized to possess and use the land only through land use
rights granted by the government. Land use rights are carried at cost
and charged to expense on a straight-line basis over the period of rights of 50
years.
(j)
|
Impairment
or disposal of long-lived assets
|
A
long-lived asset (asset group) is tested for recoverability whenever events or
changes in circumstances indicate that its carrying amount may not be
recoverable. An impairment loss is recognized only if the carrying amount of a
long-lived asset (asset group) is not recoverable and exceeds its fair value.
The carrying amount of a long-lived asset (asset group) is not recoverable if it
exceeds the sum of the undiscounted cash flows expected to result from the use
and eventual disposition of the asset (asset group). The assessment is based on
the carrying amount of the asset (asset group) at the date it is tested for
recoverability, whether in use or under development. An impairment loss is
measured as the amount by which the carrying amount of a long-lived asset (asset
group) exceeds its fair value. There were no events or changes in
circumstances that necessitated a review of impairment of long-lived assets as
of December 31, 2009 and 2008, respectively.
The
Company suffered operating losses in the years ended December 31, 2009 and 2008.
Based on an assessment performed as of December 31, 2009, Management
concluded that the sum of undiscounted cash flows expected to result from the
use of the long-lived assets exceeded their carrying amounts. Therefore,
no impairment loss was recognized for the year ended December 31,
2009.
(k)
|
Accrued
expenses and other payables
|
Accrued
expenses and other payables primarily consist of accrued commission expense,
accrued legal expense and accrued payroll expense, etc.
(l)
|
Deposits
payable
|
Deposits
payable consist of funds paid in advance by the sales representatives to obtain
the Company’s products to sell. The Company retains these deposits during the
time the sales representatives provide services to the Company. When the Company
receives full payment from the customer or sales representatives terminate sales
services, the deposits are returned to the sales representatives. The Company
records deposits from sales representatives when payments are
received.
(m)
|
Fair
value of financial instruments
|
The
carrying amounts reported in the consolidated balance sheets for accounts and
notes receivable, other receivables, advances to suppliers, accounts payable,
advances from customers, other payables and accrued expenses, deposits payable
approximate fair value because of the immediate or short-term maturity of these
financial instruments. Management believes the interest rates on short-term
notes payable and long-term debt reflect rates currently available in the PRC.
Thus, the carrying value of these loans approximates fair
value.
F-11
(n)
|
Income
and other taxes
|
CSPH and
its consolidated entities each files tax returns separately.
Value added tax
(“VAT”)
Pursuant
to the Provisional Regulation of China on VAT and their implementing rules, all
entities and individuals (“taxpayers”) that are engaged in the sale of products
in the PRC are generally required to pay VAT at a rate of 17% of the gross sales
proceeds received, less any deductible VAT already paid or borne by the
taxpayers. Further, when exporting goods, the exporter is entitled to a portion
of or all the refund of VAT that it has already paid or incurred.
CSPH’s
PRC subsidiaries are subject to VAT at 17% on their revenues.
Income
tax
The
Company follows SFAS No. 109, “Accounting for Income Taxes” (“ASC Topic 740”),
which requires the recognition of deferred tax assets and liabilities for the
expected future tax consequences of events that have been included in the
financial statements or tax returns. Under this method, deferred income taxes
are recognized for the tax consequences in future years of differences between
the tax bases of assets and liabilities and their financial reporting amounts at
each period end based on enacted tax laws and statutory tax rates, applicable to
the periods in which the differences are expected to affect taxable income.
Valuation allowances are established, when necessary, to reduce deferred tax
assets to the amount expected to be realized.
The
Company follows Financial Accounting Standards Board Interpretation No. 48,
“Accounting for Uncertainty in Income Taxes” (“ASC Topic 740”). ASC Topic 740
prescribes a more-likely-than-not threshold for financial statement recognition
and measurement of a tax position taken or expected to be taken in a tax
return. This Interpretation also provides guidance on derecognition of
income tax assets and liabilities, classification of current and deferred income
tax assets and liabilities, accounting for interest and penalties associated
with tax positions, accounting for income tax in interim periods, and income tax
disclosures. The Company did not have any interest and penalties associated with
tax positions and did not have any significant unrecognized uncertain tax
positions as of December 31, 2009 and 2008.
The
Company is not subject to any income tax in the United States, but was subject
to corporate income tax in the PRC at a unified rate of 25% for 2008. However,
because Shenghuo is located in a special region of the PRC, it has a 15%
corporate income tax rate and has been granted a “tax holiday” of two years
tax-exemption beginning from the year of 2007 and followed by 50% reduction on
the applicable income tax rate for three years.
In
accordance with the relevant tax laws and regulations of the PRC, a company
registered in the PRC is subject to state and local income taxes within the PRC
at the applicable tax rate on the taxable income. On March 16, 2007, the
National People’s Congress of China enacted a new Enterprise Income Tax Law
(“Enterprise Income Tax Law”) under which foreign invested enterprises and
domestic companies would be subject to Enterprise Income Tax Law at a uniform
rate of 25%. The Enterprise Income Tax Law became effective on January 1,
2008.
As a
result of the above change in the income tax laws, the phase-in income tax rate
for Shenghuo is 18% for 2008, 20% for 2009, 22% for 2010, 24% for 2011, 25% for
2012 and after, and it will continue to enjoy the tax holiday mentioned above.
Medicine, Import/Export, Cosmetics, Beisheng and Shi Lin are taxed at the new
25% rate effective January 1, 2008 for the year of 2009.
F-12
(o)
|
Revenue
recognition
|
The Company recognizes
revenue in accordance with Staff Accounting Bulletin ("SAB") No. 104
(“ASC Topic
605”). All of the
following criteria must exist in order for the Group to recognize revenue:
(1) persuasive
evidence of an arrangement exists; (2) delivery has occurred or services
have been rendered; (3) price to the buyer is fixed or determinable; and
(4) collectability is reasonably assured.
Delivery
does not occur until products have been shipped to the wholesale companies, risk
of loss has transferred to the wholesale companies and wholesale companies’
acceptance has been obtained, or the Company has objective evidence that the
criteria specified in wholesale companies’ acceptance provisions have been
satisfied. The sales price is not considered to be fixed or determinable until
all contingencies related to the sale have been resolved
In
general, the Company does not allow wholesale companies to return products
unless there are defects in manufacturing or workmanship. Sales returns are
subject to a strict process and have to be authorized by Management. Sales
returns are netted against sales when occurred. Historically, the amounts of
sales returns have been immaterial.
(p)
|
Subsidy
income
|
Subsidy
income received in cash from government is recognized as income in the period
received.
(q)
|
Advertising
expenses
|
Advertising
expenses, which generally represent the cost of promotions to create or
stimulate a positive image of the Company or a desire to buy the Company’s
products and services, are expensed as incurred. Advertising costs
amounting to USD39,717 and USD2,135,558 for the years ended December 31, 2009
and 2008, respectively, were recorded in the selling expenses.
(r)
|
Research
and development
|
Research
and development costs are expensed as incurred. These expenses consist of the
costs of the Company’s internal research and development activities and the
costs of developing new products and enhancing existing products. Research and
development costs amounting to USD139,944 and USD338,546 for the years ended
December 31, 2009 and 2008, respectively, were recorded in the statements of
operations.
(s)
|
Retirement
and other postretirement benefits
|
Full-time
employees of the Group in the PRC participate in a government mandated defined
contribution plan, pursuant to which certain pension benefits, medical care,
employee housing fund and other welfare benefits are provided to employees.
Chinese labor regulations require that the PRC subsidiaries of the Group make
contributions to the government for these benefits based on certain percentages
of the employees’ salaries. The Group has no legal obligation for the benefits
beyond the contributions made. The total amounts for such employee benefits,
which were expensed as incurred, were approximately USD244,250 and USD198,516
for the years ended December 31, 2009 and 2008, respectively.
(t)
|
Appropriated
retained earnings
|
The
income of CSPH’s PRC subsidiaries is distributable to its shareholder after
transfer to reserves as required by relevant PRC laws and regulations and the
subsidiaries’ articles of association. Appropriations to the reserves are
approved by the respective boards of directors.
Reserves
include statutory reserves and other reserves. Statutory reserves can
be used to make good previous years’ losses, if any, and may be converted into
capital in proportion to the existing equity interests of stockholders, provided
that the balance after such conversion is not less than 25% of the registered
capital. The appropriation of statutory reserve may cease to apply if
the balance of the fund is equal to 50% of the entity’s registered capital.
Pursuant to relevant PRC laws and articles of association of CSPH’s PRC
subsidiaries, the appropriation to the statutory reserves is 15% of net profit
after taxation of respective entity, as determined in accordance with PRC
accounting standards and regulations. The results of operations reflected in the
financial statements prepared in accordance with U.S. GAAP might differ
from those reflected in the statutory financial statements of CSPH’s PRC
subsidiaries.
F-13
(u)
|
Basic
and diluted earnings per share
|
The
computation of basic and diluted earnings per share is based on the
weighted-average number of shares outstanding during the periods presented.
Potentially dilutive securities for the years ended December 31, 2009 and 2008
include 246,000 warrants that were anti-dilutive due to losses of the
Company.
(v)
|
Credit
risk
|
The
carrying amounts of accounts receivable and sales representative advances
included in
the balance sheets represent the Company’s major exposure to credit risk in
relation to its financial assets. No other financial assets carry a significant
exposure to credit risk. The Company performs ongoing credit evaluations of each
customer’s financial condition. It maintains an allowance for doubtful accounts.
Management believes the Company’s current allowance is adequate.
(w)
|
Concentration
|
Due to
the limited availability of Sanqi the Company currently rely on a small number
of suppliers as its source for Sanqi, the primary raw material that is needed to
produce its products. Management believes that there are few alternative
suppliers available to supply the Sanqi, and should any of the current suppliers
terminate their business arrangements with the Company or increase their prices
of materials supplied, it would delay product shipments and materially adversely
affect the Company’s business operations and profitability.The Company had
concentrations of purchases raw materials from one vendor accounting for 31.6%
and 27% of total purchases for the years ended December 31, 2009 and 2008
respectively.
Approximately
85% of our sales for the year ended December 31, 2009 came from a single
product, Xuesaitong Soft Capsules, and the Company’s business may fail if this
product fails or generates materially less sales revenues. If the Company
experience delays, increased expenses, or other difficulties in the manufacture
and sale of the Xuesaitong Soft Capsules, or if the licenses and government
approvals are revoked to sell the product, or this product is no longer carried
in the Insurance Catalog, the Company may not be able to generate significant
revenues or profitability, and its business and financial condition would be
materially adversely affected and it could be forced to cease
operations.
(x)
|
Recently
enacted accounting standards
|
The
Financial Accounting Standards Board (“FASB”) establishes the Accounting
Standards Codification (“ASC”).
In June
2009, the FASB issued Accounting Standards Update No. 2009-01, “Generally
Accepted Accounting Principles” (“ASC Topic 105”) which establishes the FASB
Accounting Standards Codification (“the Codification” or “ASC”) as the official
single source of authoritative U.S. GAAP. All then existing accounting standards
were superseded. All other accounting guidance not included in the Codification
is considered non-authoritative. The Codification also includes all relevant
Securities and Exchange Commission (“SEC”) guidance organized using the same
topical structure in separate sections within the Codification.
Following
the Codification, FASB does not issue new standards in the form of Statements,
FASB Staff Positions or Emerging Issues Task Force Abstracts. Instead, it issues
Accounting Standards Updates (“ASU”) which serve to update the Codification,
provide background information about the guidance and provide the basis for
conclusions on the changes to the Codification.
F-14
The
Codification is not intended to change U.S. GAAP, but it changes the way U.S.
GAAP is organized and presented. The Codification is effective for our 2009
annual consolidated financial statements and the principal impact on our
financial statements is limited to disclosures as all future references to
authoritative accounting literature are referenced in accordance with the
Codification. In order to ease the transition to the Codification, we are
providing the Codification cross-reference alongside the references to the
standards issued and adopted prior to the adoption of the
Codification.
In
December 2007, the FASB issued SFAS No.160, “Noncontrolling Interests in
Consolidated Financial Statements (as amended)” (“ASC Topic 810-10”). This
guidance establishes accounting and reporting standards for the noncontrolling
interest in a subsidiary and for the deconsolidation of a subsidiary. It
clarifies that a noncontrolling interest in a subsidiary is an ownership
interest in the consolidated entity that should be reported as equity in the
consolidated financial statements. It changes the way the consolidated income
statement is presented and requires consolidated net income to be reported at
amounts that include the amounts attributable to both the parent and the
noncontrolling interest. It eliminates the requirement to apply purchase
accounting to a parent's acquisition of noncontrolling ownership interests in a
subsidiary. It requires that the noncontrolling interest continue to be
attributed its share of losses even if that attribution results in a deficit
noncontrolling interest balance. This guidance is effective for fiscal years,
and interim periods within those fiscal years, beginning on or after December
15, 2008. This guidance shall be applied prospectively as of the beginning of
the fiscal year in which this guidance is initially applied, except for the
presentation and disclosure requirements. The Company has retrospectively apply
the presentation and disclosure requirements for all periods presented and
believes the adoption of this guidance had no material effect on its financial
position and results of operations.
In June 2008, the Emerging Issues Task
Force (“EITF”) issued No. 07-5, “Determining Whether an Instrument (or Embedded
Feature) Is Indexed to an Entity's Own Stock” (“ASC Topic 815-40”), which is
effective for financial statements issued for fiscal years beginning after
December 15, 2008, and interim periods within those fiscal years. ASC Topic
815-40 clarifies that an exercise contingency would not preclude an instrument
(or embedded feature) from being considered indexed to an entity's own stock
provided that it is not based on (a) an observable market, other than the market
for the issuer's stock (if applicable), or (b) an observable index, other than
an index calculated or measured solely by reference to the issuer's own
operations; and that an instrument (or embedded feature) would be considered
indexed to an entity's own stock if its settlement amount will equal the
difference between the fair value of a fixed number of the entity's equity
shares and a fixed monetary amount or a fixed amount of a debt instrument issued
by the entity. The guidance shall be applied to outstanding instruments as of
the beginning of the fiscal year in which this guidance is initially applied.
The cumulative effect of the change in accounting principle shall be recognized
as an adjustment to the opening balance of retained earnings (or other
appropriate components of equity or net assets in the statement of financial
position) for that fiscal year, presented separately. The Company believes the
adoption of this guidance had no material effect on its financial position and
results of operations.
In May
2009, the FASB issued SFAS No. 165, “Subsequent Events” (“ASC Topic 855”), which
is effective for interim or annual financial periods ending after June 15, 2009.
ASC Topic 855 establishes general standards of accounting and disclosure of
events that occur after the balance sheet but before financial statements are
issued or are available to be issued. However, since the Company is a public
entity, Management is required to evaluate subsequent events through the date
that financial statements are issued and disclose the date through which
subsequent events have been evaluated, as well as the date the financial
statements were issued. This authoritative guidance became effective for interim
or annual periods ending after June 15, 2009. The adoption of this guidance
did not have a material effect on the Company’s financial
statements.
In
February 2010, FASB issued ASU No. 2010-09 (“ASC Topic 855”) which removes
the requirement for an SEC filer to disclose a date in both issued and revised
financial statements. This amendment shall be applied prospectively for interim
or annual financial periods ending after June 15, 2010. Management does not
believe the adoption will have a material effect on the Company’s financial
statements.
During
2009 and 2010, the FASB has issued several ASU’s – ASU No. 2009-02 through ASU
No. 2010-11. Except for ASU’s No. 2010-09 discussed above, the ASU’s entail
technical corrections to existing guidance or affect guidance related to
specialized industries or entities and therefore have minimal, if any, impact on
the Company.
NOTE
3 – ACCOUNTS AND NOTES RECEIVABLE, NET
Accounts
and notes receivable consisted of the following:
F-15
December 31,
|
||||||||
2009
|
2008
|
|||||||
Notes
receivable
|
$ | 852,095 | $ | 750,877 | ||||
Accounts
receivable
|
13,307,185 | 13,192,571 | ||||||
Total
|
14,159,280 | 13,943,448 | ||||||
Less:
allowance for doubtful accounts
|
2,054,984 | 4,834,745 | ||||||
$ | 12,104,296 | $ | 9,108,703 |
For the
year ended December 31, 2009, accounts receivable amounting to USD4,235,109,
which had been overdue for more than 2 years and for which a full allowance had
been provided for, were written off since they were deemed uncollectible after
Management had implemented every possible collection procedures. Additional
allowance for other doubtful accounts were provided for, with corresponding loss
amounting to USD1,532,907 charged in the consolidated statement of operations
for the year ended December 31, 2009.
NOTE
4 – OTHER RECEIVABLES, NET
Other
receivables consisted of the following:
December 31,
|
||||||||
2009
|
2008
|
|||||||
Other
receivables
|
$ | 8,345,350 | $ | 11,593,169 | ||||
Less:
allowance for doubtful accounts
|
1,651,199 | 2,955,516 | ||||||
$ | 6,694,151 | $ | 8,637,653 |
For the
year ended December 31, 2009, other receivables amounting to USD2,302,823, which
had been overdue for more than 2 years and for which a full allowance had been
provided for, were written off since they were deemed uncollectible after
Management had implemented every possible collection procedures. Additional
allowance for other doubtful accounts were provided for, with loss amounting to
USD332,316 charged in the consolidated statement of operations for the year
ended December 31, 2009.
NOTE
5 – INVENTORIES, NET
Inventories
consisted of the following:
December 31,
|
||||||||
2009
|
2008
|
|||||||
Raw
materials
|
$ | 1,048,823 | $ | 1,061,465 | ||||
Work-in-process
|
2,267,289 | 2,003,825 | ||||||
Finished
goods
|
706,424 | 648,074 | ||||||
Product
on consignment
|
- | 722,076 | ||||||
Total
inventories
|
4,022,536 | 4,435,440 | ||||||
Less:
allowance
|
126,178 | 147,978 | ||||||
$ | 3,896,358 | $ | 4,287,462 |
F-16
NOTE 6 – PROPERTY, PLANT AND
EQUIPMENT, NET
Property
and equipment consisted of the following:
|
December 31,
|
|||||||
2009
|
2008
|
|||||||
Buildings
|
$ | 5,798,896 | $ | 6,130,852 | ||||
Machinery
|
5,174,345 | 5,724,217 | ||||||
Office
equipment and furnishing
|
276,166 | 477,315 | ||||||
Vehicles
|
486,563 | 445,166 | ||||||
11,735,970 | 12,777,550 | |||||||
Less:
accumulated depreciation
|
5,367,460 | 5,341,933 | ||||||
6,368,510 | 7,435,617 | |||||||
Construction
in progress
|
5,697,042 | 146,047 | ||||||
$ | 12,065,552 | $ | 7,581,664 |
Depreciation
expenses were USD737,935 and USD821,574 for the years ended December 31, 2009
and 2008, respectively.
Certain
property, plant and equipment with the carrying amounts of USD 5.8 million were
pledged as collateral for bank loans as of December 31, 2009.
Interest
expenses that had been capitalized for construction in progress amounted to
USD19,407 for the year ended December 31, 2009.
NOTE
7 – INTANGIBLE ASSETS, NET
Intangible
assets consisted of the following:
|
December 31,
|
|||||||
2009
|
2008
|
|||||||
Land
use rights
|
$ | 1,321,725 | $ | 737,415 | ||||
Less:
accumulated amortization
|
194,501 | 71,456 | ||||||
$ | 1,127,224 | $ | 665,959 |
All the
land use rights were pledged as collateral for bank loans as of December 31,
2009.
Estimated
aggregate future amortization expense for the succeeding five years and
thereafter as of December 31, 2009 is as follows:
Succeeding year
|
Future amortization
expense
|
|||
2010
|
29,218
|
|||
2011
|
29,218
|
|||
2012
|
29,218
|
|||
2013
|
29,218
|
|||
2014
|
29,218
|
|||
Thereafter
|
981,134
|
F-17
NOTE
8 – BORROWINGS
The
Company’s borrowings are payable to banks and governmental financial bureaus.
The following summarizes the Company’s debt obligations and respective balances
as of December 31, 2009 and 2008:
December
31,
|
||||||||||||||||||||||||
Short-term
borrowings
|
2009
|
2008
|
||||||||||||||||||||||
Lenders
|
Maturity
Date
|
Interest
Rate
|
Balance
|
Maturity
Date
|
Interest
Rate
|
Balance
|
||||||||||||||||||
CCB,
secured by land use rights, buildings and machinery
|
April 2010
|
5.31 | % | $ | 3,656,468 |
April 2009
|
7.47 | % | $ | 3,647,399 | ||||||||||||||
CCB,
(note a)
|
(note
a)
|
4.86 | % | 1,650,992 | - | - | - | |||||||||||||||||
Agricultural
Bank of China (ABC), guaranteed by stockholders
|
- | - | - |
August 2009
|
7.72 | % | 5,835,838 | |||||||||||||||||
Financial
bureau, unsecured
|
Due
on demand
|
4.50 | % | 75,369 |
Due
on demand
|
4.50 | % | 75,182 | ||||||||||||||||
Financial
bureau, unsecured
|
Due
on demand
|
1.80 | % | 73,129 |
Due
on demand
|
1.80 | % | 72,948 | ||||||||||||||||
Financial
bureau, secured by property
|
- | - | - |
Due
on demand
|
2.43 | % | 218,844 | |||||||||||||||||
$ | 5,455,958 | $ | 9,850,211 |
December 31,
|
||||||||||||||||||||||
Long-term
borrowings
|
2009
|
2008
|
||||||||||||||||||||
Lenders
|
Maturity
Date
|
Interest
Rate
|
Balance
|
Maturity
Date
|
Interest
Rate
|
Balance
|
||||||||||||||||
ABC,
(note b & c)
|
March
2010
|
8.316 | % | $ | 1,462,587 |
March
2010
|
8.316 | % | $ | 1,458,959 | ||||||||||||
CCB,
secured by land use rights, buildings and machinery
|
March
2010
|
5.40 | % | 1,462,587 |
March
2010
|
6.57 | % | 2,917,919 | ||||||||||||||
ABC,
(note c)
|
April
2011
|
5.40 | % | 731,293 | - | - | - | |||||||||||||||
ABC,
(note c)
|
August
2011
|
5.40 | % | 5,119,055 | - | - | - | |||||||||||||||
ABC,
(note c)
|
June
2010
|
5.40 | % | 438,776 | - | - | - | |||||||||||||||
ABC,
(note c)
|
December 2010
|
5.40 | % | 585,035 | - | - | - | |||||||||||||||
Total
long-term borrowings
|
$ | 9,799,333 | $ | 4,376,878 | ||||||||||||||||||
Less:
current maturities of long- term borrowings
|
3,948,985 | 3,245,685 | ||||||||||||||||||||
Long-term
borrowings, net of current portion
|
$ | 5,850,348 | $ | 1,131,193 | ||||||||||||||||||
Past
due borrowing (note b)
|
$ | 292,517 | $ | 294,026 |
F-18
(a) As of December 31,
2009, short-term borrowings, amounting to USD1,650,992, were pledged by accounts
receivable,
amounting to USD2,063,740 at interest rates of approximately 4.86%, maturing
within three months from withdrawing dates.
(b) Of
the aggregate amount USD1,462,587 borrowed from ABC, USD292,517 fell due in May
2009 and past due as of December 31, 2009. However, based on the Company’s good
historical credit record, the Company reached an oral agreement with the lender
to extend the maturity date for this portion of the loan to March 2010.
Therefore the Company did not repay the amount of the loan originally due in May
2009.
(c) On
August 6, 2009, the Company obtained a one-year line of credit from ABC
amounting to RMB110 million (approximately USD16 million) based on the ABC’s
assessment of the Company’s operations and unencumbered assets. As of December
31, 2009, the balance of borrowings from ABC was RMB57 million (approximately
USD 8.3 million), among which, borrowing amounting to USD1,462,587 was secured
by land use rights and buildings, while aggregate amount of USD6,874,159 was
guaranteed by the CSPH’s 94.95% shares in Shenghuo. The unused line of credit as
of December 31, 2009 was RMB53 million (approximately USD7.7 million) which
requires additional collaterals.
(d) The
weighted average interest rates on short-term borrowings outstanding were 4.91%
and 5.47% for the years ended December 31, 2009 and 2008,
respectively.
(e) The
Company’s total borrowings amounting to USD15,255,291 as of December 31, 2009
included USD9,404,943 maturing in 2010 and USD5,850,348 maturing in
2011.
NOTE
9 – RELATED PARTY TRANSACTIONS
Receivables
from related parties as of December 31 2009 mainly consist of receivables from
Kun Ming Dianjiao Nutritional Supplements Co., Ltd. (“Dianjiao”), which is under
common control with the Company, and accounts due from officers for daily
purchases, amounting to USD151,581 and USD265,913, respectively. These amounts
are due on demand and do not accrue interest.
Related
party sales to Dianjiao amounted to USD99,000 for the year ended December 31,
2009.
NOTE
10 – WARRANTS
The
following summarizes the outstanding warrants as of December 31,
2009:
Exercisable
Date
|
Title
|
Exercise
Price
|
Number of
Warrants
Outstanding
|
Weighted-Average
Remaining
Contractual
Life (Years)
|
Number of
Warrants
Exercisable
|
|||||||||||||
June
2007
|
Non-employee
directors
|
$ | 3.5 | 6,000 | 2.75 | 6,000 | ||||||||||||
June
2007
|
Westpark
Capital
|
$ | 4.2 | 40,000 | 2.55 | 40,000 | ||||||||||||
June
2007
|
CCG
Investor Relations Partners LLC(“CCG”)(1)
|
$ | 3.5 | 200,000 | 1.30 | 200,000 | ||||||||||||
246,000 | 246,000 |
As of
December 31, 2009, Exercise prices are significantly higher than the Company’s
stock price which was approximately USD0.78. Management believes that it is
unlikely that these warrants will be exercised.
(1) The
warrant granted to CCG in April 2007 was subject to adjustment, in which, if the
Company issues additional common shares after the date of the warrant in an
issuance of additional common shares at a price below the warrant exercise price
(“dilutive issue”), the warrant price shall be reduced to the new series of a
conversion price (as such term is defined in the amended and restated articles
of incorporation of the Company, as hereinafter amended from time to time) after
the dilutive issue. Changes in the fair value of the warrant
deemed to be material in the future will be reflected in earnings during that
reporting period with a corresponding increase or decrease to the warrant
liability on the balance sheet.
F-19
NOTE
11 – INCOME TAXES AND OTHER TAXES
(a)
|
Taxes
and related payables
|
Taxes and
related payables are composed of the following:
December 31,
|
||||||||
2009
|
2008
|
|||||||
VAT,
net
|
$ | 863,960 | $ | 533,533 | ||||
Income
tax
|
228,394 | 655,476 | ||||||
Other
taxes
|
1,977 | 47,565 | ||||||
$ | 1,094,331 | $ | 1,236,574 |
(b)
|
Deferred
tax assets, net
|
The
temporary differences and carryforwards which give rise to the deferred income
tax assets are as follows:
December 31,
|
||||||||
2009
|
2008
|
|||||||
Net
operating loss carryforwards
|
$ | 1,074,094 | $ | 3,256,071 | ||||
Deductible
advertising expense carryforwards
|
412,152 | - | ||||||
Allowance
for doubtful trade and other receivables
|
924,239 | 968,125 | ||||||
Unpaid
accrued expense
|
737,722 | - | ||||||
Inventory
obsolescence reserve
|
57,058 | 13,881 | ||||||
Total
deferred income tax assets
|
3,205,265 | 4,238,077 | ||||||
Less:
Valuation allowance
|
1,985,075 | 4,238,077 | ||||||
$ | 1,220,190 | $ | - |
Medicine,
Import/Export and Cosmetic, have an aggregate tax loss carryforwards available
amounting to approximate USD4.3 million, which begins to expire in 2011, if
unused by the offset of future taxable income of the individual subsidiaries.
The following table below summaries the expiration dates of tax loss
carryforwards.
Expiration year
|
Tax loss carryforwards
|
|||
2011
|
$ | 748,906 | ||
2012
|
474,983 | |||
2013
|
366,910 | |||
2014
|
1,758,130 | |||
2015
|
947,448 | |||
$ | 4,296,377 |
F-20
(c)
|
Income
tax (benefit) expense
|
Following
is a reconciliation of income taxes calculated at the statutory rates to actual
income tax expense:
|
Years Ended December 31,
|
|||||||
2009
|
2008
|
|||||||
Tax
at statutory rate of 25%
|
$ | (1,962,809 | ) | $ | (929,079 | ) | ||
Effect
of favorable rate
|
262,266 | 86,240 | ||||||
Effect
of reduction in statutory rates
|
524,533 | (293,479 | ) | |||||
Non-deductible
expenses
|
114,898 | - | ||||||
Additional
deduction
|
(6,997 | ) | - | |||||
Change
in valuation allowance
|
82,150 | 1,574,597 | ||||||
Others
|
(68,021 | ) | - | |||||
Income
tax (benefit) expense
|
$ | (1,053,980 | ) | $ | 438,279 |
For the
year ended December 31, 2009, the effect of difference between the statutory tax
rate and the applicable tax rate resulted in an increase of income tax benefit
of approximate USD0.25 million, and a decrease of loss per share by approximate
USD0.01.
The
income taxes (benefit) expense consisted of the following:
Years End December 31,
|
||||||||
2009
|
2008
|
|||||||
Current
tax expenses
|
$ | 165,675 | $ | 438,279 | ||||
Adjustments
of the beginning-of-the-year balance
of a valuation allowance
|
(336,674 | ) | - | |||||
Benefits
of operating loss carryforwards
|
(88,549 | ) | - | |||||
Other
deferred tax benefit
|
(794,432 | ) | - | |||||
Income
tax (benefit) expense
|
$ | (1,053,980 | ) | $ | 438,279 |
In
December 2009, by implementing a tax planning strategy, which was to allocate
sufficient future taxable income to Medicine before the expiration of its tax
loss carryforwards, Management concluded that it was more likely than not that
the correspondent deferred tax assets would be realized and therefore decreased
the beginning-of-the-year balance of valuation allowance. The accumulated tax
loss carryforwards of Medicine as of December 31, 2008 amounted to USD1.35
million and the tax loss carryforwards for the year ended December 31, 2009 was
USD 0.35 million, resulting in correspondent deferred tax asset amounting to USD
336,674 and USD 88,549 as of December 31, 2008 and 2009,
respectively.
F-21
Management
believes that the remaining tax loss carryforwards of Cosmetic and Import/Export
amounting to approximately 2.6 million is unlikely to be deductable in the
future years, therefore the corresponding deferred tax assets were recognized
with full allowance provided.
NOTE
12–SEGMENT REPORTING
Management
regards “Medicine products” and “Cosmetic products” as their operating
segments. However, no segment reporting is necessary as “Cosmetic
products” does not meet the quantitative thresholds for a reportable segment. As
the Group primarily generates its revenues from customers in the PRC, no
geographical segments are presented.
NOTE
13 – COMMITMENTS AND CONTINGENCIES
(a)
|
Operating
lease commitment
|
The
Company signed an agreement with Management Commission of Kunming Shilin Taiwan
Farmer Entrepreneur Centre(“Entrepreneur Centre”) in August 2009 to rent land to
plant suitable for cultivating the medicinal herb Panax notoginseng for use in
the production of the Company’s medicinal products. The total operating lease
amount was approximately USD15 million in a lease period of 21 years. However,
the Entrepreneur Centre failed to hand over the land and fulfilled the contract
terms in time. Therefore the lease agreement is subject to further
negotiation.
(b)
|
Capital
Commitment
|
As of
December 31, 2009, capital commitments for constructing new buildings were
totalling USD1,344,789, which will be settled within one year.
(c)
|
Class
Action Lawsuits
|
In 2008,
putative class action lawsuits were asserted against the Company and certain
other parties in the United States District Court for the Southern District of
New York (the “Court”). On February 12, 2009, an amended complaint was served on
the Company by new lead counsel for the class, consolidating the putative class
actions and bearing the caption Beni Varghese, Individually and on Behalf of All
Other Similarly Situated v. China Shenghuo Pharmaceutical Holdings, Inc., et
al., Index No. 1:08 CIV. 7422. The defendants include the Company, the Company’s
controlling shareholders, Lan’s International Medicine Investment Co., Limited,
the Company’s chief executive officer, Gui Hua Lan, the Company’s former chief
financial officer, Qiong Hua Gao, and the Company’s former independent
registered public accounting firm, Hansen, Barnett & Maxwell, P.C. Both the
Company and the accounting firm filed motions to dismiss the complaint, but
those motions were denied by the Court. A scheduling order has been
entered by the Court anticipating that the parties will engage in substantive
discovery in 2010.
The
amended consolidated complaint alleges that the Company failed to take adequate
steps to ensure its financial reporting comported with U.S. GAAP and, as a
result, the Company was required to restate what are alleged to be materially
false and misleading financials for accounting periods during the alleged class
period from August 2007 through August 20, 2008. The amended consolidated
complaint further alleges, among other things, that certain of the Company’s SEC
filings and other public statements contained false and misleading statements
that resulted in damages to the plaintiffs and the members of the purported
class when they purchased the Company’s securities. On the basis of those
allegations, plaintiffs in each of the actions seek an unspecified amount of
damages under Sections 10(b) and 20(a) of the Exchange Act, and Rule 10b-5
promulgated there under.
F-22
The
Company believes the allegations in the amended consolidated complaint are
without merit, and intends to vigorously defend the class action lawsuits. The
Company does not believe the outcome of this suit will have a material adverse
effect on the Company. However, the Company is unable at this time to predict
the outcome of this litigation or whether the Company will incur any liability
associated with the litigation, or to estimate the effect such outcome would
have on the financial condition, results of operations, or cash flows of the
Company based on the opinion of the counsel.
Other
litigation has arisen in the normal course of the Company’s business, none of
which is deemed to be material.
NOTE
14– SUBSEQUENT EVENTS
As
of April
14, 2010, which is the financial statement issuance date,
Management identified the following subsequent events:
The
Long-term borrowing from ABC, amounting to USD1,462,587 ,which originally fell
due on March 25, 2010, was renewed in February 2010 with a new maturity date of
January 31, 2011.
On March
30, 2010, the Company obtained a short-term borrowing from the financial bureau
amounting to USD5,119,055, with maturity date of April 13, 2010, and
repaid the borrowings from CCB, amounting to USD1,462,587 and USD 3,656,468,
which would fall due in March and April, 2010 respectively. On April 7, 2010,
Management withdrew loan facility amounting to USD6,201,369 from ABC under the
unused line of credit to repay the above borrowing from the financial
bureau.
F-23