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EX-32 - RULE 13A-14(B) CERTIFICATION - AOXING PHARMACEUTICAL COMPANY, INC.axn10q20101231ex32.htm
EX-31.2 - RULE 13A-14(A) CERTIFICATION - CFO - AOXING PHARMACEUTICAL COMPANY, INC.axn10q20101231ex31-2.htm
EX-31.1 - RULE 13A-14(A) CERTIFICATION - CEO - AOXING PHARMACEUTICAL COMPANY, INC.axn10q20101231ex31-1.htm


United States
Securities and Exchange Commission
Washington, D. C. 20549

FORM 10-Q

[X]
QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
   
 
For the quarterly period ended December 31, 2010
   
[ ]
TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
          For the transition period from _____ to _____

Commission File No. 1-32674

AOXING PHARMACEUTICAL COMPANY, INC.
(Exact Name of Registrant as Specified in its Charter)

                   Florida                   
            65-0636168             
(State or Other Jurisdiction of
(I.R.S. Employer I.D. No.)
incorporation or organization)
 

15 Exchange Place, Suite 500, Jersey City, NJ 07302
(Address of Principal Executive Offices)

Issuer's Telephone Number: (646) 367-1747

Indicate  by check mark  whether the  Registrant  (1) has filed all reports required to be filed by Sections 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   X                    No ___
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files.)  Yes ____ No _____
 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check One)
 
Large accelerated filer ___ Accelerated filer ___ Non-accelerated filer ___ Small reporting company   X  

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes ___   No    X  

APPLICABLE ONLY TO CORPORATE ISSUERS:  Indicate the number of shares outstanding of each of the Registrant's classes of common stock, as of the latest practicable date:
February 14, 2010
Common Stock: 46,505,519
 
 
 

 
 
AOXING PHARMACEUTICALCOMPANY, INC.
QUARTERLY REPORT ON FORM 10Q
FOR THE FISCAL QUARTER ENDED DECEMBER 31, 2010
 

TABLE OF CONTENTS

   
Page No
Part I
Financial Information
 
     
Item 1.
Financial Statements:
 
 
Consolidated Balance Sheet – December 31, 2010 (unaudited) and
 
 
     June 30, 2009
2
 
Consolidated Statements of Operations and Other Comprehensive
 
 
     Income (Loss) – for the Three and Six Months Ended December 31,
 
 
    2010 and 2009 (Unaudited)
3
 
Consolidated Statements of Cash Flows – for the Six Months
 
 
     Ended December 31, 2010 and 2009 (Unaudited)
4
 
Notes to Consolidated Financial Statements (Unaudited)
5
Item 2.
Management’s Discussion and Analysis of Financial Condition and
 
 
     Results of Operations
11
Item 3
Quantitative and Qualitative Disclosures about Market Risk
16
Item 4.
Controls and Procedures
16
     
Part II
Other Information
 
     
Item 1.
Legal Proceedings
16
Items 1A.
Risk Factors
16
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
17
Item 6.
Exhibits
17
Signatures


 
 

 

AOXING PHARMACEUTICAL CO., INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
             
             
   
December
   
June
 
   
2010
   
2010
 
   
(Unaudited)
       
             
ASSETS
CURRENT ASSETS:
           
     Cash
  $ 2,808,746     $ 3,985,710  
     Accounts receivable, net of allowance for doubtful accounts of $3,112,168 and $2,575,177, respectively
    2,237,217       1,724,198  
     Loan receivable
    480,029       748,790  
     Inventory
    1,622,431       1,564,975  
     Deposits with suppliers
    459,224       475,042  
     Prepaid expenses and sundry current assets
    605,710       421,391  
TOTAL CURRENT ASSETS
    8,213,357       8,920,106  
                 
LONG - TERM ASSETS
               
     Property and equipment, net of accummulated depreciation
    26,856,493       25,569,782  
     Other intangible assets
    1,415,721       1,431,182  
     Goodwill
    19,495,171       19,012,321  
     Deferred tax assets
    3,786,313       3,394,103  
TOTAL LONG-TERM ASSETS
    51,553,698       49,407,388  
                 
TOTAL ASSETS
  $ 59,767,055     $ 58,327,494  
                 
LIABILITIES AND STOCKHOLDERS' EQUITY
                 
CURRENT LIABILITIES:
               
     Short-Term borrowings
  $ 983,091     $ 293,746  
     Accounts payable
    3,502,815       2,965,514  
     Current portion of long term debt - other
    102,846       46,999  
     Current portion of long term debt - related parties
    146,865       94,760  
     Accrued expenses and taxes payable and other sundry current liabilities
    2,459,485       2,076,555  
     Loan payable - Bank
    8,318,461       8,078,019  
TOTAL CURRENT LIABILITIES
    15,513,563       13,555,593  
                 
LONG-TERM DEBT-- RELATED PARTIES
    6,517,505       6,329,118  
                                     -- OTHER
    2,272,954       2,221,943  
WARRANT AND DERIVATIVE LIABILITIES
    796,511       1,913,534  
                 
Common stock, par value $0.001, 100,000,000 shares authorized, 46,502,108 and 46,494, 903 shares issued and outstanding at December 31,2010 and June 30, 2010, respectively
    46,502       46,495  
Additional paid in capital
    49,865,766       49,594,553  
Accumulated deficit
    (16,302,794 )     (15,598,600 )
Other comprehensive income
    1,354,728       525,555  
TOTAL STOCKHOLDERS' EQUITY OF THE COMPANY
    34,964,202       34,568,003  
                 
NONCONTROLLING INTEREST IN SUBSIDIARIES
    (297,680 )     (260,697 )
TOTAL EQUITY
    34,666,522       34,307,306  
                 
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY
  $ 59,767,055     $ 58,327,494  
 
  
See notes to consolidated financial statements 
 
 
2

 

AOXING PHARMACEUTICAL CO., INC. AND SUBSIDIARIES
 
CONSOLIDATED STATEMENTS OF OPERATIONS AND OTHER COMPREHENSIVE INCOME (LOSS)
 
(Unaudited)
 
                         
                         
   
For the three months ended
   
For the six months ended
 
   
December 31,
   
December 31,
 
   
2010
   
2009
   
2010
   
2009
 
                         
SALES
  $ 1,940,539     1,556,431     3,681,212     $ 3,003,094  
COST OF SALES
    775,846       540,516       1,603,141       990,659  
GROSS PROFIT
    1,164,693       1,015,915       2,078,071       2,012,435  
                                 
COSTS AND EXPENSES:
                               
  Research and development expense
    191,950       78,761       277,398       192,064  
  General and administrative expenses
    1,247,180       825,503       2,156,236       1,702,987  
  Selling expenses
    362,071       287,404       873,892       548,297  
  Depreciation and amortization
    150,262       109,473       302,306       218,690  
      TOTAL COSTS AND EXPENSES
    1,951,463       1,301,141       3,609,832       2,662,038  
                                 
LOSS FROM OPERATIONS
    (786,770 )     (285,226 )     (1,531,761 )     (649,603 )
                                 
OTHER INCOME (EXPENSE):
                               
  Interest expense, net of interest income
    (385,327 )     (451,070 )     (760,108 )     (1,043,155 )
  Change in fair value of warrant and derivative liabilities
    894,306       4,623,692       1,117,023       2,481,533  
  Gain on foreign currency transactions
    0       241       0       241  
  Loss on disposal of assets
    0       0       0       (21,415 )
  Forgiveness of debt
    0       3,579,085       0       3,579,085  
     TOTAL OTHER INCOME (EXPENSE)
    508,979       7,751,948       356,915       4,996,289  
                                 
INCOME (LOSS) BEFORE INCOME TAXES
    (277,791 )     7,466,722       (1,174,846 )     4,346,686  
                                 
Income taxes (credit)
    (189,613 )     2,020,568       (392,210 )     1,211,315  
NET INCOME ( LOSS)
    (88,178 )     5,446,154       (782,636 )     3,135,371  
                                 
Net income attributed to non-controlling interest
    (37,923 )     163,984       (78,442 )     147,808  
INCOME (LOSS) ATTRIBUTABLE TO THE SHAREHOLDERS OF THE COMPANY
    (50,255 )     5,282,170       (704,194 )     2,987,563  
                                 
OTHER COMPREHENSIVE INCOME ( LOSS) :
                               
  Foreign currency translation adjustment
    649,958       (27,744 )     870,632       9,934  
                                 
COMPREHENSIVE INCOME (LOSS)
  $ 599,703     $ 5,254,426     $ 166,438     $ 2,997,497  
                                 
Other comprehensive income attributable to non-controlling interest
    30,950       0       41,459       0  
                                 
COMPREHENSIVE INCOME (LOSS) ATTRIBUTABLE TO THE COMPANY
  $ 568,753     $ 5,254,426     $ 124,979     $ 2,997,497  
                                 
                                 
BASIC AND DILUTED EARNINGS (LOSSES) PER COMMON SHARE
    0.01       0.06       0.00       0.03  
WEIGHTED AVERAGE NUMBER OF SHARES OUTSTANDING
    46,494,981       91,669,562       46,494,942       89,540,442  
      
   
See notes to consolidated financial statements
 
 
3

 

AOXING PHARMACEUTICAL CO., INC. AND SUBSIDIARIES
 
CONSOLIDATED STATEMENTS OF CASH FLOWS
 
(Unaudited)
 
             
   
For the six months ended
 
   
December 31,
 
   
2010
   
2009
 
             
OPERATING ACTIVITIES:
           
 Net income (loss)
  $ (704,194 )   $ 2,987,563  
   Adjustments to reconcile net loss to net cash used in operating activities:
         
      Depreciation and amortization
    576,962       538,657  
      Deferred tax assets
    (392,210 )     1,211,315  
      Loss on desposal on assets
    -       21,416  
      Forgiveness of debt
    -       (3,640,718 )
      Non-cash interest expense related to debentures and warrants
    -       89,561  
      Stock issued for services   
    252,559       273,454  
      Change in fair value of warrants and derivative liability
    (1,117,023 )     (2,481,533 )
      Minority interest
    (78,442 )     147,808  
  Changes in operating assets and liabilities:
               
       Accounts receivable
    (469,755 )     (189,611 )
       Inventories
    (10,874 )     (413,919 )
       Prepaid expenses and sundry current assets
    (134,167 )     (187,396 )
       Accounts payable
    449,032       122,885  
       Accrued expenses, taxes and sundry current liabilities
    298,371       922,215  
NET CASH USED IN OPERATING ACTIVITIES
    (1,329,741 )     (598,303 )
                 
INVESTING ACTIVITIES:
               
  Acquisition of property and equipment
    (1,044,528 )     (420,692 )
  Loans to unrelated parties
    291,049       -  
  Cash Proceeds from sale of assets
    -       950,626  
NET CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES
    (753,479 )     529,934  
                 
FINANCING ACTIVITIES:
               
  Repayment of bank loan
    -       (4,270,485 )
  Short-term borrowings
    680,601       -  
  Other borrowings
    39,324       3,753,122  
  Loans from related party
    49,457       715,504  
  Sale of common stock
    -       5,000,000  
NET CASH PROVIDED BY FINANCING ACTIVITIES
    769,382       5,198,141  
                 
EFFECT OF EXCHANGE RATE ON CASH
    136,874       (17,979 )
                 
INCREASE (DECREASE) IN CASH
    (1,176,964 )     5,111,793  
CASH – BEGINNING OF YEAR
    3,985,710       1,271,922  
CASH – END OF PERIOD
  $ 2,808,746       6,383,715  
                 
Supplemental disclosures of cash flow information:
               
  Non-cash financing activities:
               
     Conversion of 33MM RMB AOB loan  and accrued interest into common stock
    -       4,830,847  
     Cash paid for interest
    588,227       -  
     Cash paid for income tax
    235,103       -  
     
 
See notes to consolidated financial statements
  
 
4

 

AOXING PHARMACEUTICAL CO., INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2010
(Unaudited)
 
 
1              BASIS OF PRESENTATION
 
The accompanying unaudited consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles for interim financial information and pursuant to the requirements for reporting on Form 10-Q. Accordingly, they do not include all the information and footnotes required by accounting principles generally accepted in the United States of America for annual financial statements. However, the information included in these interim financial statements reflects all adjustments (consisting solely of normal recurring adjustments) which are, in the opinion of management, necessary for the fair presentation of the consolidated financial position and the consolidated results of operations. Results shown for interim periods are not necessarily indicative of the results to be obtained for a full year. The consolidated balance sheet as of June 30, 2010 was derived from the audited consolidated financial statements included in the Company’s Annual Report on Form 10-K for the fiscal year 2010. These interim financial statements should be read in conjunction with that report.
 
For further information, refer to the consolidated financial statements and footnotes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended June 30, 2010 filed on October 4, 2010.
 
 
2             BUSINESS DESCRIPTION AND SIGNIFICANT ACCOUNTING POLICIES

Aoxing Pharmaceutical Co., Inc. (“the Company” or ‘Aoxing Pharma”) is a specialty pharmaceutical company specializing in research, development, manufacturing and distribution of a variety of narcotics and pain-management products.  In March 2010, the Company changed to its current name from “China Aoxing Pharmaceutical Co., Inc.”

As of December 31, 2010, the Company had one operating subsidiary: Hebei Aoxing Pharmaceutical Co., Inc. (“Hebei”), which is organized under the laws of the People’s Republic of China (“PRC”).  As of December 31, 2010 the Company owned 95% of the issued and outstanding common stock of Hebei.

Since 2002, Hebei has been engaged in developing narcotics and pain management products, building its facilities and obtaining the requisite licenses from the Chinese Government.  Headquartered in Shijiazhuang City, the pharmaceutical capital of China, outside of Beijing, Hebei now has China's largest and the most advanced manufacturing facility for highly regulated narcotic medicines, addressing a very under-served and fast-growing market in China. Its facility is one of the few GMP facilities licensed for manufacturing narcotics medicines. The Company is working closely with the Chinese government and SFDA to assure the strictly regulated availability to medical professionals throughout China of its narcotic drugs and pain medicines.
     
Use of estimates in the preparation of financial statements

The preparation of the unaudited consolidated financial statements in conformity with generally accepted accounting principles in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the condensed consolidated financial statements, and the reported amounts of revenue and expenses during the reporting period. Significant estimates reflected in the consolidated financial statements include, but are not limited to, the recoverability of the carrying amount and estimated useful lives of long-lived assets, allowance for accounts receivable, realizable values for inventories, valuation allowance of deferred tax assets, purchase price allocation of its acquisitions and share-based compensation expenses. Management makes these estimates using the best information available at the time the estimates are made; however, actual results when ultimately realized could differ from those estimates.

 
5

 
 
Impairment of long lived assets
 
Long-lived assets are reviewed for impairment when circumstances indicate the carrying value of an asset may not be recoverable.  For assets that are to be held and used, impairment is recognized when the estimated undiscounted cash flows associated with the asset or group of assets is less than their carrying value.  If impairment exists, an adjustment is made to write the asset down to its fair value, and a loss is recorded as the difference between the carrying value and fair value.  Fair values are determined based on quoted market values, discounted cash flows or internal and external appraisals, as applicable.  Assets to be disposed of are carried at the lower of carrying value or estimated net realizable value.
  
Derivative financial instruments

The Company’s derivative financial instruments consist of embedded derivatives related to the convertible debentures and warrants.  The accounting treatment of derivative financial instruments requires that the Company record the derivatives and related warrants at their fair values as of the inception date of the debt agreements and at fair value as of each subsequent balance sheet date.  Any change in fair value was recorded as non-operating, non-cash income or expense at each balance sheet date.  If the fair value of the derivatives was higher at the subsequent balance sheet date, the Company recorded a non-operating, non-cash charge.  If the fair value of the derivatives was lower at the subsequent balance sheet date, the Company recorded non-operating, non-cash income.

For the six months ended December 31, 2010, the Company recognized other income of $1,117,023 as compared to other income of $2,481,533 for the six months ended December 31, 2009, relating to recording the changes in fair value of warrant and derivative liabilities.  As of December 31, 2010 and 2009 there were $796,511 and $887,368 of warrant and derivative liabilities, as the related debt instruments were not settled.

The Company’s derivative instruments were valued using the Black-Scholes option pricing model, based on the following historic data and assumptions on December 31, 2010:

Estimated dividends
None
Expected volatility
59.58%
Risk-free interest rate
0.19%
Expected term (years)
0.71

The expected volatility was determined based on the historic quoted market price of the common stock.  Risk free interest rate was determined based on the quoted US treasury rate under the same expected term with each corresponding financial instrument.

 
6

 
 
New Accounting Pronouncements
 
In March 2010, FASB issued ASU No. 2010-11 –Scope Exception Related to Embedded Credit Derivatives. Embedded credit-derivative features related only to the transfer of credit risk in the form of subordination of one financial instrument to another are not subject to potential bifurcation and separate accounting as clarified by recently issued FASB guidance. Other embedded credit-derivative features are required to be analyzed to determine whether they must be accounted for separately. This update provides guidance on whether embedded credit-derivative features in financial instruments issued by structures such as collateralized debt obligations (CDOs) and synthetic CDOs are subject to bifurcation and separate accounting. The guidance is effective at the beginning of a company’s first fiscal quarter beginning after June 15, 2010. The Company does not expect the adoption of this ASU to have a material impact on the Company’s consolidated financial statements.
 
In April 2010, the FASB issued ASU No. 2010-13, Compensation – Stock Compensation: Effect of Denominating the Exercise Price of a Share-Based Payment Award in the Currency of the Market in Which the Underlying Equity Security Trades. ASU 2010-13 clarifies that a share-based payment award with an exercise price denominated in the currency of a market in which a substantial portion of the entity’s equity securities trades should not be considered to contain a condition that is not a market, performance, or service condition. Therefore, such an award should not be classified as a liability if it otherwise qualifies as equity. ASU 2010-13 is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2010, with early adoption permitted. The Company is currently evaluating the potential impact of this standard.


3              INVENTORIES

Inventories consist of the following:

   
December 31
   
June 30
 
   
2010
   
2010
 
             
Work in process
  $ 142,110     $ 119,327  
Raw materials
    920,799       449,137  
Finished goods
    559,522       996,511  
    $ 1,622,431     $ 1,564,975  

 
4             SHORT-TERM BORROWINGS

Short-term borrowing consists of (a) a non-interest bearing note payable to Shi Jia Zhuang Finance Bureau, and agency of a local government, due three months after the Company is listed on NASDAQ, and (b) a short term note payable to Bo Hai International Trust, bearing interest at 30% per annum and due on March 2, 2011.

   
December 31
   
June 30
 
   
2010
   
2010
 
             
Shi Jia Zhuang Finance Bureau (a)
  $ 226,867     $ 293,746  
Bo Hai International Trust (b)
    756,224       -  
    $ 983,091     $ 293,746  


 
7

 

5              ACCRUED EXPENSES AND OTHER SUNDRY LIABILITIES

Accrued expenses and taxes consist of the following:

   
December 31
   
June 30
 
   
2010
   
2010
 
             
Accrued salaries and benefits
  $ 375,796     $ 308,693  
Accrued interest
    1,303,834       1,073,890  
Accrued taxes
    268,253       52,637  
Other accrued expenses and sundry liabilities
    511,602       641,335  
    $ 2,459,485     $ 2,076,555  


6             LOAN PAYABLE - BANK

Loans payable – bank consist of the following:

   
December 31
   
June 30
 
   
2010
   
2010
 
             
Bank Note in the amount of 30 million RMB with Bank of Communications of China bearing an annual floating rate of  5.841%, set to be 10% higher than the interest rate of the China People Bank rate, maturing April 22, 2011
  $ 4,537,342     $ 4,406,192  
Bank Note in the amount of 25 million RMB with China Citic Bank bearing an annual floating rate of  5.841%, set to be 10% higher than the interest rate of the China People Bank rate, maturing May 4, 2011
    3,781,119       3,671,827  
    $ 8,318,461     $ 8,078,019  


7             LONG-TERM DEBT – OTHER

Long-term debt – other consists of the following:

   
December 31
   
June 30
 
   
2010
   
2010
 
             
Loans payable bearing interest at 10% and 25% per annum and maturing on March and December 2012
  $ 2,272,954     $ 2,221,943  
Loans from unrelated third parties maturing on various dates through August 2011 and bearing interest at rates ranging from 6%-10%
    102,846       46,999  
    $ 2,375,800     $ 2,268,942  
Less current portion
    102,846       46,999  
    $ 2,272,954     $ 2,221,943  


 
8

 
 
8             LONG-TERM DEBT – RELATED PARTIES

Loan from related parties consists of the following:

   
December 31
   
June 30
 
   
2010
   
2010
 
             
Loans maturing on March and December 31, 2012 bearing interest from 5% to 25% per annum
  $ 6,517,505     $ 6,329,118  
Loans maturing on various dates through August 17, 2011, bearing interest at a rate ranging from 7.2%-10%
    146,865       94,760  
    $ 6,664,370     $ 6,423,878  
Less current portion
    146,865       94,760  
    $ 6,517,505     $ 6,329,118  


9             TAXES
 
The Company’s Chinese subsidiaries are governed by the Income Tax Law of the People’s Republic of China concerning private-run enterprises, which are generally subject to tax at a statutory rate of 25% on income reported in the statutory financial statements after appropriate tax adjustments.

The reconciliation of income tax at the U.S. statutory rate to the Company’s effective tax rate is as follows:
 
   
Six months ended December 31,
 
   
2010
   
2009
 
             
U.S. Statutory rate
  $ (382,012 )   $ 1,521,340  
Tax rate differential between China and U.S.
    156,883       (295,617 )
Change in valuation allowance
    (167,081 )     (14,408 )
Effective tax rate
  $ (392,210 )   $ 1,211,315  
 
 
 
9

 
 
The provisions of income taxes are summarized as follows:
 
   
Six months ended December 31,
 
   
2010
   
2009
 
             
Deferred - United States
    67,081        
Deferred - China
    (392,210 )     1,225,723  
Change in valuation allowance
    (167,081 )     (14,408 )
Total
    (392,210 )     1,211,315  
 
 
10           CONCENTRATIONS

Sales to two major customers were 27% and 14% for the three months ended December 31, 2010, and 29% and 11% for the three months ended December 31, 2009.

Sales of three major products represented approximately 81%, 5% and 5% of total sales for the three months ended December 31, 2010, and 68%, 11% and 9% of total sales for the three months ended December 31, 2009.

Sales to two major customers were 27% and 13% for the six months ended December 31, 2010, and 32% and 12% for the six months ended December 31, 2009.

Sales of three major products represented approximately 79%, 3% and 3% of total sales for the six months ended December 31, 2010, and 70%, 13% and 10% of total sales for the six months ended December 31, 2009.


11           SUBSEQUENT EVENTS

In accordance with ASC 855, “Subsequent Events”, the Company has evaluated subsequent events that have occurred through the date these financial statements were issued and has determined that there were no material events that occurred after the date of the balance sheets included in this report.

 
10

 

ITEM 2.  MANAGEMENT’S DISCUSSION AND ANALYSIS
 
PRELIMINARY NOTE REGARDING FORWARD-LOOKING STATEMENTS
 
This quarterly report contains forward-looking statements within the meaning of the federal securities laws. These include statements about our expectations, beliefs, intentions or strategies for the future, which we indicate by words or phrases such as “anticipate,” “expect,” “intend,” “plan,” “will,” “we believe,” “Aoxing Pharma believes,” “management believes” and similar language. The forward-looking statements are based on the current expectations of Aoxing Pharma and are subject to certain risks, uncertainties and assumptions, including those set forth in our Annual Report on Form 10-K for the fiscal year ended June 30, 2010 under Item 1A:  “Risk Factors.” Actual results may differ materially from results anticipated in these forward-looking statements. We base the forward-looking statements on information currently available to us, and we assume no obligation to update them.
 
Outline of Our Business

Aoxing Pharmaceutical Company, Inc. (the “Company” or “Aoxing Pharma”) is a Florida incorporated specialty pharmaceutical company with its main operations in China, specializing in research, development, manufacturing and distribution of a variety of narcotics and pain-management products.  Its common stock is currently trading on the NYSE AMEX under the ticker symbol of “AXN”.  Our product line is comprised of prescription and over-the-counter pharmaceutical products.  Our pharmaceutical products have been approved by the Chinese State Food and Drug Administration, or SFDA, based on demonstrated safety and efficacy. We sell our products primarily to hospitals, clinics, pharmacies and retail in most of the provinces of China, including rural areas and major cities.
 
In April 2010 Aoxing Pharma and Johnson Matthey Plc entered into an agreement to establish a joint venture through affiliated companies focused on research, development, manufacturing and marketing of active pharmaceutical ingredients (“API”) for narcotics and neurological drugs for the China market. The joint venture represents a significant new opportunity for both companies to expand their business in the rapidly growing pharmaceutical market in China.
 
Under the terms of the agreement, Macfarlan Smith Ltd, a wholly owned subsidiary of Johnson Matthey Plc, headquartered in the United Kingdom, will contribute technology expertise and capital to the joint venture.  Hebei Aoxing Pharmaceutical Group Company, Ltd (“Hebei Aoxing”), the operating subsidiary of Aoxing Pharma, will contribute capital, fixed assets and related API manufacturing licenses.  The joint venture company will be called Hebei Aoxing API Pharmaceutical Company, Ltd.  Hebei Aoxing will have a 51% stake in the Company, while Macfarlan Smith (Hong Kong) Ltd, (a wholly owned subsidiary of Johnson Matthey Pacific Ltd), will hold 49%.  Each company will have equal representation on a board of directors that will oversee a management team responsible for corporate strategies and operations.

The new joint venture is located on the Hebei Aoxing campus in Xinle City, 200 kilometers south west of Beijing.  The joint venture received a manufacturing license in November 2010 and a business license in January 2011 for its first product, Naloxone Hydrochloride.  It plans to begin manufacturing during 2011.

 
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In February 2010, Aoxing Pharma and QRxPharma Ltd. announced a strategic alliance to collaborate in the development of two proprietary narcotic drugs in China and ex-China markets: MoxDuo®IV, an intravenous formulation, as well as MoxDuo®IR, an immediate release capsule presently in pivotal Phase 3 studies in the United States.  Both products are based on QRxPharma’s patented morphine and oxycodone Dual-Opioidtechnology for the acute treatment of moderate to severe pain.  Under the terms of the agreement, Aoxing Pharma will fund the development of MoxDuo®IV and MoxDuo®IR for the China market in exchange for exclusive marketing rights in China.  QRxPharma will retain ownership of both products and may use the clinical work completed by Aoxing Pharma for product registration purposes outside of China.  Extensive clinical studies have demonstrated QRxPharma’s Dual-Opioids™ provide as good or better pain relief than either morphine or oxycodone alone, but with significantly fewer side effects, giving doctors and patients more options in the treatment of moderate to severe pain from the hospital to the home.

Pharmaceutical Market in China: According to IMS health, the global pharmaceutical market in 2011 is expected to be about $880 billion and expected to grow 5-7% in 2011 while the Chinese pharmaceutical market is expected to grow 25-27% in 2011 to more than $50 billion, making it the third largest pharmaceutical market behind the United States and Japan.  The growth in Chinese pharmaceutical market is driven by several factors including improving standards of living and an increase in disposable income fueled by the growing economy, the aging population, the increasing participation in the State Basic Medical Insurance System and the increase in government spending on public health care. In January 2009, the Chinese government approved a healthcare reform plan and has budgeted RMB 850 billion, or $124 billion, for a three year program to make medical services and products more affordable and accessible to the whole population.
 
Narcotics Industry in China: The pharmaceutical market in China is highly fragmented today. We believe there are over 3,000 small enterprises currently engaged in the development, manufacture and sale of pharmaceutical products, and we expect significant consolidation of pharmaceutical business, products and technologies in China in near future.  However, based on recent statistics provided by the China SFDA, there are only 13 pharmaceutical companies designated by the China SFDA as narcotic drug producers in China.
 
Regulatory and Quality Control: Each of our pharmaceutical products has certain medicinal functions and has demonstrated safety and efficacy in accordance with the China SFDA requirements for the treatment of at least one or more therapeutic indications.  Our products are produced in various formulations, such as injection, tablets, capsules, oral solution and powders.  Our manufacturing facility in China is GMP certified, fully integrated with manufacturing support systems including quality assurance, quality control and regulatory compliance. We have developed our own independent quality control systems in accordance with SFDA regulations. Our quality assurance team devotes significant attention to quality control for designing, manufacturing and testing our products, and is also responsible for ensuring that we are in compliance with all applicable national and local regulations and standards, as well as our internal policies. Our senior management team is also actively involved in setting quality assurance policies and managing internal and external quality performance. These support systems enable us to maintain high standards of quality for our products and deliver reliable products to our customers on a timely basis.

 
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Results of Operations
 
Revenues for the three months ended December 31, 2010 were $1,940,539, representing 24.7% increase over the revenues of $1,556,431 realized during the three months ended December 31, 2009.  For the six months ended December 31, 2010, the revenues were $3,681,212, a 22.6% increase from the revenues of $3,003,094 realized during the six months ended December 31, 2009.  The increase in revenue in the three and six months ended December 31, 2010 reflects the positive impact of our recent sales team expansion.

Cost of sales was $775,846 for the three months ended December 31, 2010, which was 43.5% more than the $540,516 in costs incurred during the three months ended December 31, 2009.  The gross margin ratio was decreased from 65.3% in the three months ended December 2009 to 60% in the three months ended December 2010.  For the six months ended December 31, 2010, our cost of sales was $1,603,141, which was 61.8% more than the $990,659 in costs incurred during the six months ended December 2009.  The gross margin ratio was decreased from 67% in the six months ended December 31, 2009 to 56.5% in the six months ended December 31, 2010.  The main reasons for the increase in cost of sales were increases in raw materials and cost of labor.

Gross profit was $1,164,693 during the three months ended December 31, 2010, 14.6% higher than the same period a year earlier, reflecting the combined effects of higher sales and lower gross margin rate.  During the six months ended December 31, 2010, gross profit was $2,078,071, 3.3% higher than the same period a year earlier.  The small increase reflects higher sales that were negatively impacted by lower gross margin.

Research and development expenses were $191,950 during the three months ended December 31, 2010, representing a 144% increase from $78,761 occurred during the three months ended December 31, 2009.  During the six months ended December 31, 2010, our research and development expenses were $277,398, representing a 44% increase from $192,064 spent during the same period a year earlier.  Our R&D expenses could fluctuate significantly from period to period, reflecting the progress and timing of our various development projects.

General and administrative expenses were $1,247,180 in the three months ended December 31, 2010, 51% higher than $825,503 in the three months ended December 31, 2009.  For the six months ended December 31, 2010, general and administrative expenses were $2,156,236, 27% higher than $1,702,987 incurred during the six months ended December 31, 2009. Bad debt expenses of $457,352 incurred in the three months ended December 31, 2010 is the most significant factor for the increased G&A expenses.  As a result of our periodic review and continuous efforts to collect our accounts receivable, we increased our bad debt reserve on December 31, 2010. We sell our products to both distributors and retailers, and the payment terms range from 30 days to 90 days from invoice date or receipt of goods, whichever is later. We evaluate collectability of our accounts receivable periodically and provide a bad debt reserve based on their aging and the results of our collection action.  As of December 31, 2010, we performed an aging analysis of each customer, and determined that an additional provision for bad debt was needed. The revaluation led us to record a bad debt expense of $457,352 during our second fiscal quarter.  In the corresponding fiscal quarter in 2009, we did not record any bad debt expense.

 
13

 

Selling expenses in the amount of $362,071 incurred during the three months ended December 31, 2010 were 26% higher from $287,404 spent on selling during the three months ended December 31, 2009.  During the six months ended December 31, 2010, selling expenses in the amount of $873,892 were 59.4% higher than $548,297 spent on selling during the same period a year ago. The increase was mainly due to expansion of our sales and marketing personnel, which contributed to higher sales volume.

Our loss from operations for the quarter ended December 31, 2010, increased to $786,770, slightly higher than $744,991 incurred in previous quarter, but 176% higher than $285,226 incurred during the quarter ended December 31, 2009.  For the six months ended December 31, 2010, loss from operations increased 136% to $1,531,761 from $649,603 incurred from the same period a year earlier. The significant increase in the loss was primarily due to bad debt expense, expansion of our sales and marketing team and increase in research and development.

Interest expense was $385,327 for the three months ended December 31, 2010, a 14.6% decrease from the interest expense of $451,070 for the three months ended December 31, 2009. The reduction of interest expense was primarily due to payoff of a convertible debenture in May 2010.

The volatility in the market price of our common stock has a significant impact on the fair valuation of our outstanding warrant liabilities.  During the quarter ended December 31, 2010, this value decreased by $894306, primarily due to a decline in the market price of our common stock.  The decrease was recorded as other income for the three months ended December 31, 2010.   In the three months ended December 31, 2009, decline in the market price of our common stock led to a decline of $4,623,692 in the fair value of outstanding warrants and other derivative liabilities, with a corresponding other income in that amount.

The Company realized a net loss of $88,178 for the three months ended December 31, 2010.  However, because the Company owns only 95% of Hebei Aoxing, 5% of that company’s income was attributed to the minority interest.  Therefore the net loss for the three months ended December 31, 2010 was $50,255 attributable to the shareholders of Aoxing Pharmaceutical.  In comparison, during the three months ended December 31, 2009, there was a net gain to the Company’s shareholders in the amount of $5,282,170, after deducting income attributable to the 5% minority interest in Hebei Aoxing.

During the six months ended December 31, 2010, net loss to the shareholders of Aoxing Pharmaceutical was $704,194, as compared to a net gain of $2,987,563 for the same period a year earlier, excluding the 5% minority interest.  The net gain from the periods in 2009 was primarily due to non-operating income: specifically $2,481,533 in other income attributable to the reduction in the value of outstanding warrants and $3,579,085 in other income attributable to the decision of the Bank of China to forgive that portion of our bank debt.

 
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Liquidity and Capital Resources

Our operations during the six months ended December 31, 2010 used $1,329,741 in cash, as compared to $598,303 used for operations during the six months ended December 31, 2009.  The primary reason for the increased use of cash in the recent quarter was a $469,755 increase in our accounts receivable, and the fact that in the six months ended December 31, 2009 we preserved cash by increasing our accrued expenses by $922,215.

Our investing activities used $753,479 in cash during the six months ended December 31, 2010.  We purchased additional property and equipment in the amount of $1,044,528, although that expenditure was partially offset by the receipt of loan payment in the amount of $291,049.  During the six months ended December 31, 2009 our investing activities provided us $529,934 in cash, as we received the proceeds from sale of a previous manufacturing facility.

Our cash flows from financing activities amounted to $769,382 during the six months ended December 31, 2010.  On September 2, 2010, we completed a 6-month loan financing in the total amount of $756,224 (RMB 5 million) to improve our working capital situation.  The short-term loan, which matures on March 2, 2011, is expected to be extended after that date.  Part of the fund, $75,622 (RMB 0.5 million), was used to reduce the principal of a previous short term loan. Net cash flows from financing in the six months ended December 31, 2009 were $5,198,141, primarily due to the fact that in the first quarter of fiscal year 2010, specifically in August 2009, we completed a private placement to a total of fifteen institutional and other accredited investors of 5,263,158 of shares of the Company’s common stock at a purchase price of $0.95 per share, which yielded gross proceeds of $5 million.  We continue seeking additional funding to support our business operation and to further improve our capital structure.   At the present time we have no commitment from any source for additional funds.
 
As a result of the several debt refinancing during fiscal 2010 and the first quarter of fiscal 2011, our debt service obligations at December 31, 2010 were:
 

Contractual Obligations
 
Total
   
Less than 1 Year
   
1-3 Years
    4-5 Years     After 5 Years  
Loans Payable
                                 
- Bank
 
$
8,318,461
   
$
8,318,461
   
$
-
    $       $    
- Related Party
   
6,664,370
     
146,865
     
6,517,505
                 
- Others
   
2,375,800
     
102,846
     
2,272,954
                 
- Short-term
   
983,091
     
983,091
                         
     TOTAL
 
$
18,341,722
   
$
9,551,263
   
$
8,790,459
    $       $    

We continue to explore various alternatives in order to secure sources of financing and improve our financial position.  Among the possibilities being considered are new credit facilities, a new equity raise, arrangements to license intellectual property, and a sale of selected property rights.  At the present time we have no commitment from any source for additional funds.
 
Off-Balance Sheet Arrangements
 
We do not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition or results of operations.

 
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ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Not applicable.

ITEM 4.  CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures.  Our Chief Executive Officer and Chief Financial Officer carried out an evaluation of the effectiveness of our disclosure controls and procedures as of December 31, 2010.  Pursuant to Rule13a-15(e) promulgated by the Securities and Exchange Commission pursuant to the Securities Exchange Act of 1934, “disclosure controls and procedures” means controls and other procedures that are designed to insure that information required to be disclosed by Aoxing Pharmaceutical in the reports that it files with the Securities and Exchange Commission is recorded, processed, summarized and reported within the time limits specified in the Commission’s rules.  “Disclosure controls and procedures” include, without limitation, controls and procedures designed to insure that information Aoxing Pharmaceutical is required to disclose in the reports it files with the Commission is accumulated and communicated to our Chief Executive Officer and Chief Financial Officer as appropriate to allow timely decisions regarding required disclosure.  Based on their evaluation, our Chief Executive Officer and Chief Financial Officer concluded that Aoxing Pharmaceutical’s system of disclosure controls and procedures was effective as of December 31, 2010 for the purposes described in this paragraph.

Changes in Internal Controls.  There was no change in internal controls over financial reporting (as defined in Rule 13a-15(f) promulgated under the Securities Exchange Act or 1934) identified in connection with the evaluation described in the preceding paragraph that occurred during Aoxing Pharmaceutical’s second fiscal quarter that has materially affected or is reasonably likely to materially affect Aoxing Pharmaceutical’s internal control over financial reporting.

PART II   -   OTHER INFORMATION

Item 1. Legal Proceedings
 
At present, the company is not engaged in or the subject of any material legal proceedings.
 
 
Item 1A. Risk Factors.
 
There have been no material changes from the risk factors included in the Annual Report on Form 10-K for the year ended June 30, 2010.
 
 
16

 

Item 2.   Unregistered Sale of Securities and Use of Proceeds

(a) Unregistered sales of equity securities

None.

 (c) Purchases of equity securities

The Company did not repurchase any of its equity securities that were registered under Section 12 of the Securities Exchange Act during the 3rd quarter of fiscal 2010.

Item 6.    Exhibits

 
31.1
Rule 13a-14(a) Certification – CEO
 
31.2
Rule 13a-14(a) Certification – CFO
 
32
Rule 13a-14(b) Certification

SIGNATURES

Pursuant to the  requirements  of the Securities  Exchange Act of 1934, the Registrant  has duly  caused  this  Report  to be  signed  on its  behalf by the undersigned thereunto duly authorized.

 
AOXING PHARMACEUTICAL COMPANY, INC.
   
Date: February 14, 2010
By: /s/ Zhenjiang Yue
 
       Zhenjiang Yue, Chief Executive Officer
   
Date: February 14, 2010
By: /s/ Bob Ai
 
       Bob Ai, Chief Financial Officer, Chief Accounting Officer
 

 
 
17