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EX-31.2 - Shengtai Pharmaceutical, Inc.v211171_ex31-2.htm
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EX-31.1 - Shengtai Pharmaceutical, Inc.v211171_ex31-1.htm

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

(Mark One)

QUARTERLY REPORT PURSUANT TO 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 EXCHANGE ACT

For the transition period from ______________ to _____________

Commission file number: 000-51312

SHENGTAI PHARMACEUTICAL, INC.
 (Exact name of registrant as specified in its charter)
 
Delaware
 
54-2155579
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer  Identification No.)
 
 Changda Road East, Development District,
Changle County, Shandong, The People’s Republic of China
 
 
262400
(Address of principal executive offices)
 
(Zip Code)

011-86-536-6295802
(Registrant’s telephone number, including area code)
 
 
(Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant (1) has filed 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 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.

Large accelerated filer
 ¨
Accelerated filer
 ¨
       
Non-accelerated filer
 ¨
Smaller reporting company
 x

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

APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY
PROCEEDINGS DURING THE PRECEDING FIVE YEARS:
Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Sections 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court.
Yes   ¨  No  ¨    

APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

As of February 14, 2011, there are 9,584,912 shares of $0.001 par value common stock issued and outstanding.

 

 

FORM 10-Q
SHENGTAI PHARMACEUTICAL, INC.

INDEX

       
Page
         
PART I.
 
Financial Information
 
3
         
   
Item 1.  Financial Statements
 
3
         
   
Consolidated Unaudited Balance Sheets as of December 31, 2010 and June 30, 2010
 
3
         
   
Consolidated Unaudited Statements of Income and Other Comprehensive Income for the Three and Six Months Ended December 31, 2010 and 2009
 
4
         
   
Consolidated Unaudited Statements of Cash Flows for the Six Months Ended December 31, 2010 and 2009
 
5
         
   
Notes to Unaudited Consolidated Financial Statements as of December 31, 2010
 
6
         
   
Item 2.  Management's Discussion and Analysis of Financial Condition and Results of Operations
 
26
         
   
Item 3.  Quantitative and Qualitative Disclosures About Market Risk
 
32
         
   
Item 4.  Controls and Procedures
 
32
         
PART II.
 
Other Information
 
32
         
   
Item 1.  Legal Proceedings
 
32
         
   
Item 1A. Risk Factors
 
32
         
   
Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds
 
32
         
   
Item 3.  Defaults Upon Senior Securities
 
32
         
   
Item 4.  (Removed and Reserved)
 
32
         
   
Item 5.  Other Information
 
32
         
   
Item 6.  Exhibits
 
33

 
2

 

PART I - FINANCIAL INFORMATION

Item 1. Financial Statements
 
CONSOLIDATED BALANCE SHEETS
AS OF DECEMBER 31, 2010 AND JUNE 30,2010
(UNAUDITED)

   
DECEMBER 31,
   
JUNE 30,
 
   
2010
   
2010
 
   
(UNAUDITED)
       
ASSETS
           
             
CURRENT ASSETS:
           
Cash & cash equivalents
  $ 6,827,127     $ 4,121,541  
Restricted cash
    3,640,800       16,556,904  
Accounts receivable, net of allowance for doubtful accounts of $2,211,523 as of December 31, 2010 and $1,306,268 as of June 30, 2010, respectively
    14,064,809       8,365,822  
Notes receivable
    1,124,023       2,410,512  
Other receivables
    682,528       450,284  
Inventories
    16,539,263       11,072,170  
Prepayments and other assets
    1,246,806       545,590  
Total current assets
    44,125,357       43,522,824  
                 
PLANT AND EQUIPMENT, net
    80,261,536       75,373,851  
                 
OTHER ASSETS:
               
Investment in Changle Shengshi Redian Co., Ltd.
    6,859,927       6,372,294  
Advances for construction
    1,349,722       2,334,748  
Intangible assets - land use right, net of accumulated amortization
    3,216,590       3,150,894  
Total other assets
    11,426,238       11,857,936  
                 
Total assets
  $ 135,813,131     $ 130,754,611  
                 
LIABILITIES AND SHAREHOLDERS' EQUITY
               
                 
CURRENT LIABILITIES:
               
Accounts payable and accured liabilities
  $ 13,508,036     $ 9,508,631  
Accounts payable and accrued liabilities - related party
    1,061,947       252,017  
Notes payable - banks
    7,281,600       17,823,300  
Short term loans
    47,724,820       40,153,980  
Accrued liabilities
    652,370       412,555  
Other payable
    1,070,235       1,315,797  
Employee loans
    385,339       396,404  
Other payable - officer
    531,116       515,856  
Customer deposit
    7,685,913       4,162,046  
Taxes payable
    700,172       1,456,474  
Long term loan-current matunties
    640       2,314,983  
Total current liabilities
    80,602,188       78,312,043  
                 
LONG TERM LIABILITIES
               
Other payable - noncurrent
    -       3,346,336  
Total long term liabilities
    -       3,346,336  
                 
Total liabilities
    80,602,188       81,658,379  
                 
COMMITMENTS AND CONTINGENCIES
               
                 
SHAREHOLDERS' EQUITY:
               
Preferred stock, $0.001 par value, 2,500,000 shares authorized, no shares issued and outstanding
    -       -  
Common stock, $0.001 par value, 50,000,000 shares authorized, 9,584,912 shares issued and outstanding
    9,585       19,170  
Additional paid-in capital
    21,498,295       21,305,230  
Statutory reserves
    3,713,669       3,214,800  
Retained earnings
    23,192,455       19,351,772  
Accumulated other comprehensive income
    6,796,940       5,205,259  
Total shareholders' equity
    55,210,943       49,096,231  
                 
Total liabilities and shareholders' equity
  $ 135,813,131     $ 130,754,611  

The accompanying notes are an integral part of this statement.

 
3

 

SHENGTAI PHARMACEUTICAL INC. AND SUBSIDIARIES
CONSOLIDATE STATEMENTS OF INCOME AND OTHER COMPREHENSIVE INCOME
FOR THE THREE AND SIX MONTHS ENDED DECEMBER 31, 2010 AND 2009
(UNAUDITED)

   
THREE MONTHS ENDED DECEMBER 31
   
SIX MONTHS ENDED DECEMBER 31
 
   
2010
   
2009
   
2010
   
2009
 
NET SALES
  $ 49,044,856     $ 28,508,859     $ 83,689,428     $ 51,635,916  
                                 
COST OF SALES
    43,145,306       24,039,512       71,770,521       43,845,212  
                                 
GROSS PROFIT
    5,899,550       4,469,347       11,918,907       7,790,704  
                                 
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
    2,103,390       2,195,676       4,683,194       4,280,366  
                                 
INCOME FROM OPERATIONS
    3,796,160       2,273,671       7,235,713       3,510,338  
                                 
OTHER (EXPENSE) INCOME:
                               
Earnings on equity investment
    144,244       200,963       231,133       347,109  
Non-operating income
    54,614       (24,229 )     77,611       199,362  
Non-operating expense
    (94,804 )     (9,076 )     (201,852 )     (16,346 )
Interest expense and other charges
    (427,576 )     (913,532 )     (1,550,692 )     (1,642,318 )
Interest income
    70,770       (607 )     72,034       775  
Other income (expense), net
    (252,752 )     (746,481 )     (1,371,764 )     (1,111,418 )
                                 
INCOME BEFORE PROVISION FOR INCOME TAXES
    3,543,408       1,527,190       5,863,949       2,398,920  
                                 
PROVISION FOR INCOME TAXES
    846,940       474,964       1,524,397       562,861  
                                 
NET INCOME
    2,696,468       1,052,226       4,339,552       1,836,059  
                                 
OTHER COMPREHENSIVE ITEMS:
                               
Foreign currency translation adjustments
    763,135       332       1,591,681       61,634  
                                 
COMPREHENSIVE INCOME
  $ 3,459,603     $ 1,052,558     $ 5,931,233     $ 1,897,693  
                                 
EARNINGS PER SHARE
                               
Basic
  $ 0.28     $ 0.11     $ 0.45     $ 0.19  
Diluted
  $ 0.27     $ 0.11     $ 0.45     $ 0.19  
                                 
WEIGHTED AVERAGE NUMBER OF SHARES
                               
Basic
    9,584,912       9,584,903       9,584,912       9,584,903  
Diluted
    9,809,676       9,584,903       9,732,089       9,584,903  

The accompanying notes are an integral part of this statement.

 
4

 

CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE SIX MONTHS ENDED DECEMBER 31, 2010 AND 2009
(UNAUDITED)

   
2010
   
2009
 
             
CASH FLOWS FROM OPERATING ACTIVITIES:
           
Net income
  $ 4,339,552     $ 1,836,059  
Adjustments to reconcile net income to cash provided by operating activities:
               
Depreciation
    3,560,415       3,830,468  
Amortization
    27,949       28,164  
Allowance for bad debts
    851,731       (254,370 )
Share based compensation to employees
    183,480       317,636  
Loss on equipment disposal
    111,874       -  
Gain on disposal of land use right
    -       (739 )
Earnings on equity investment
    (231,133 )     (347,109 )
Change in operating assets and liabilities:
               
Accounts receivable
    (5,357,856 )     1,872,130  
Notes receivable
    1,450,732       (263,189 )
Other receivables
    (876,791 )     (227,480 )
Inventories
    (5,111,530 )     (1,725,029 )
Prepayments and advance to employees
    (308,910 )     (186,545 )
Accounts payable
    3,653,269       739,842  
Accrued liabilities
    228,578       18,125  
Accounts payable - related party
    788,967       146,971  
Other payable
    (746,316 )     1,134,035  
Customer deposit
    3,342,622       789,599  
Taxes payable
    (786,417 )     1,025,045  
Net cash provided by operating activities
    5,120,215       8,733,614  
                 
CASH FLOWS FROM INVESTING ACTIVITIES:
               
Advances-Short term loan receivable
    -       (837,341 )
Purchase plant and equipment
    (1,204,598 )     (2,258,175 )
Proceeds from equipment disposal
    (0 )     2,535  
Additions to construction in progress
    (5,059,744 )     (5,517,268 )
Advances for construction
    1,037,108       -  
Acquisition of land use right
    -       (43,415 )
Loan to related party - non-current
    (851,731 )     -  
Net cash used in investing activities
    (6,078,966 )     (8,653,664 )
                 
CASH FLOWS FROM FINANCING ACTIVITIES:
               
Decrease in restricted cash
    12,916,104       20,557,383  
Borrowings on notes payable - banks
    -       13,197,600  
Principal payments on notes payable - banks
    (10,888,680 )     (35,252,256 )
Borrowings on short term loans
    12,231,120       14,018,784  
Principal payments on short term loans
    (5,966,400 )     (6,393,504 )
Principal payments on employee loans
    (22,523 )     (266,991 )
Borrowings on third party loan
    335,610       11,986  
Principal payments on third party loan
    -       69,381  
Borrowings on long term loans
    4,778,788       -  
Payments on long term loans
    (4,778,788 )     -  
Payment on capital lease obligation
    (5,732,806 )     (1,929,709 )
Net cash provided by financing activities
    2,872,424       4,012,675  
                 
EFFECTS OF EXCHANGE RATE CHANGE IN CASH
    791,911       3,737  
                 
INCREASE IN CASH & CASH EQUIVELENTS
    2,705,584       4,096,362  
                 
CASH & CASH EQUIVELENTS, beginning of period
    4,121,543       1,779,476  
                 
CASH & CASH EQUIVELENTS, end of period
  $ 6,827,127     $ 5,875,838  
                 
SUPPLEMENTAL DISCLOSURE
               
Cash paid for Interest, net of capitalized interest
  $ 1,361,124     $ 1,827,539  
Cash paid for Income taxes
  $ 1,672,926     $ -  
Non-cash construction in progress transferring into plant and equipment
  $ 575,344     $ -  

The accompanying notes are an integral part of this statement.

 
5

 
 
SHENGTAI PHARMACEUTICAL INC. AND SUBSIDIARIES
DECEMBER 31, 2010
(UNAUDITED)
  
Note 1 - Organization background and principal activities

Shengtai Pharmaceutical, Inc, the "Company,” was incorporated in March 2004 in the State of Delaware. The Company, through its direct and indirect subsidiaries, manufactures and distributes glucose and starch as pharmaceutical raw materials, other starch products and other glucose products such as corn meals, food and beverage glucose and dextrin. The Company's manufacturing operations are in the People's Republic of China, the "PRC,” and the Company sells its products both in China and overseas.

Note 2 - Summary of significant accounting policies
  
The reporting entity

The consolidated financial statements of Shengtai Pharmaceutical, Inc. and its subsidiaries reflect the activities of the parent and its wholly-owned subsidiaries Shengtai Holding, Inc., “SHI,” and Weifang Shengtai Pharmaceutical Co., Ltd., “Weifang Shengtai.” The Company recorded all normal recurring adjustments considered necessary to give a fair presentation of operating results for the periods presented. Interim results are not necessarily indicative of results for a full year. The information included in this Form 10-Q should be read in conjunction with information included in the 2010 annual report filed on Form 10-K. The results of the three-month period ended December 31, 2010 are not necessarily indicative of the results to be expected for the full fiscal year ending June 30, 2011.

Basis of presentation

The accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America. All material inter-company transactions and balances have been eliminated in the consolidation.

Use of estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. The significant estimates made in the preparation of the Company's consolidated financial statements relate to the assessment of the fair value of stock based compensation, and the collectability of accounts receivable. Actual results could be materially different from these estimates upon which the carrying values were based.

Foreign currency translation

The reporting currency of the Company is the US dollar. The Company uses the Chinese Renminbi, "RMB,” as its functional currency. In accordance with Statement of Financial Accounting Standards "SFAS" 52, "Foreign Currency Translation," results of operations and cash flows are translated at average exchange rates during the period, and assets and liabilities are translated at the unified exchange rates at the balance sheet dates, and equity is translated at the historical exchange rates. As a result, amounts related to assets and liabilities reported on the statements of cash flows will not necessarily agree with changes in the corresponding accounts on the balance sheets. Translation adjustments resulting from this process are included in accumulated other comprehensive income in the statements of shareholders' equity. Transaction gains and losses that arise from exchange rate fluctuations on transactions denominated in a currency other than the functional currency are included in the results of operations as incurred.

 
6

 

Assets and liabilities were translated at 6.59 RMB and 6.81 RMB to $1.00 at December 31, 2010 and June 30, 2010, respectively. The equity accounts were stated at their historical rate. The average translation rates applied to income statement for the six months ended December 31, 2010 and 2009 were 6.70 RMB and 6.82 RMB to $1.00. Cash flows are also translated at average translation rates for the period; therefore, amounts reported on the statement of cash flows will not necessarily agree with changes in the corresponding balances on the balance sheet.

Revenue recognition

The Company recognizes revenue when the goods are delivered, title has passed, pricing is fixed, and collection is reasonably assured. Sales revenue represents the invoiced value of goods, net of value-added tax (“VAT”), and estimated returns of product from customers. Most of the Company’s products sold in the PRC are subject to a VAT rate of 17% of the gross sales price or at a rate approved by the Chinese local government. This VAT may be offset by VAT paid by the Company on raw materials and other materials included in the cost of producing their finished products and certain freight expenses. The Company allows its customers to return products only if its products are later determined by the Company to be ineffective.Based on the Company’s historical experience, product returns have been insignificant throughout all of its product lines. Therefore, the Company does not estimate deductions or allowance for sales returns. Sales returns are taken against revenue when products are returned from customers. Sales are presented net of any discounts given to customers.
  
Shipping and handling

Shipping and handling costs related to costs of goods sold are included in selling, general and administrative expenses. Shipping and handling costs related to costs of good sold amounted to $1,314,754 and $1,123,730 for the three months ended December 31, 2010 and 2009, respectively. Shipping and handling costs amounted to $2,272,840 and $2,273,694 for the six months ended December 31, 2010 and 2009, respectively.
  
Financial instruments

ASC 825 (formerly SFAS 107, "Disclosures about Fair Value of Financial Instruments"), defines financial instruments and requires disclosure of the fair value of those instruments.  ASC 820 (formerly SFAS 157, "Fair Value Measurements"), adopted July 1, 2008, defines fair value, establishes a three-level valuation hierarchy for disclosures of fair value measurement and enhances disclosure requirements for fair value measures. The carrying amounts reported in the balance sheets for current receivables and payables, including short term loans, qualify as financial instruments and are a reasonable estimate of fair value because of the short period of time between the origination of such instruments and their expected realization and, if applicable, the stated rate of interest is equivalent to rates currently available. The three levels are defined as follows:
 
Level 1:
inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets.

Level 2:
inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the assets or liability, either directly or indirectly, for substantially the full term of the financial instruments.

Level 3:
inputs to the valuation methodology are unobservable and significant to the fair value.

The Company did not identify any assets or liabilities that are required to be presented on the balance sheet at fair value in accordance with ASC 820 (formerly SFAS 157).

 
7

 

Stock-based compensation

The Company records stock-based compensation expense pursuant to ASC 718 (Originally issued SFAS 123R, “Share Based Payment.”) The Company uses the Black-Scholes option pricing model which requires the input of highly complex and subjective variables including the expected life of options granted and the Company’s expected stock price volatility over a period equal to or greater than the expected life of the options. Because changes in the subjective assumptions can materially affect the estimated value of the Company’s employee stock options, it is management’s opinion that the Black-Scholes option pricing model may not provide an accurate measure of the fair value of the Company’s employee stock options. Although the fair value of employee stock options is determined in accordance with SFAS 123R using an option pricing model, that value may not be indicative of the fair value observed in a willing buyer/willing seller market transaction.

Stock-based compensation expense is recognized based on awards expected to vest, and there were no estimated forfeitures as the Company has a short history of issuing options. ASC 718 (Originally issued SFAS 123R) requires forfeitures to be estimated at the time of grant and revised in subsequent periods, if necessary, if actual forfeitures differ from those estimates.
  
Earnings per share

The Company reports earnings per share in accordance with the provisions of ASC 260 (Originally issued SFAS No. 128 (“SFAS 128”), "Earnings Per Share.") ASC 260 requires presentation of basic and diluted earnings per share in conjunction with the disclosure of the methodology used in computing such earnings per share. Basic earnings per share excludes dilution and is computed by dividing income available to common stockholders by the weighted average common shares outstanding during the period. Diluted earnings per share takes into account the potential dilution that could occur if securities or other contracts to issue common stock were exercised and converted into common stock.

The following is a reconciliation of the basic and diluted earnings per share:
  
   
Three months ended
December 31,
 
   
2010
   
2009
 
   
(Unaudited)
   
(Unaudited)
 
             
Net income for earnings per share
  $ 2,696,468     $ 1,052,226  
                 
Weighted average shares used in basic computation
    9,584,912       9,584,903  
                 
Diluted effect of warrants
    224,764       -  
                 
Weighted average shares used in diluted computation
    9,809,676       9,584,903  
                 
Earnings per share
               
                 
Basic
  $ 0.28     $ 0.11  
                 
Diluted
  $ 0.27     $ 0.11  

 
8

 

   
Six months ended
December 31,
 
   
2010
   
2009
 
   
(Unaudited)
   
(Unaudited)
 
             
Net income for earnings per share
  $ 4,339,552     $ 1,836,059  
                 
Weighted average shares used in basic computation
    9,584,912       9,584,903  
                 
Diluted effect of warrants
    147,177       -  
                 
Weighted average shares used in diluted computation
    9,732,089       9,584,903  
                 
Earnings per share
               
                 
Basic
  $ 0.45     $ 0.19  
                 
Diluted
  $ 0.45     $ 0.19  
   
For the three and six months ended December 31, 2009, no warrants or stock options were included in the calculation of diluted earnings per share because there are no diluted effects for the three and six months ended December 31, 2010.

For the three and six months ended December 31, 2010, 4,398,945 shares of warrants were included in the calculation of diluted earnings per share. No stock options were included in the calculation of diluted earnings per share because there are no diluted effects for the three and six months ended December 31, 2010.

Cash and cash equivalents

The Company considers all highly liquid investments with original maturities of three months or less to be cash and cash equivalents.
  
Restricted cash

The Company through its bank agreements is required to keep certain amounts on deposit that are subject to withdrawal restrictions. As of December 31, 2010 and June 30, 2010, these amounts totaled $3,640,800 and $16,556,904, respectively. A large amount of cash was released from the Restricted cash account after bank notes matured.

In accordance with the Escrow Agreement and the Share Purchase Agreement signed by Shengtai Holding Inc., West Coast Car Company, Chinamerica Fund LP and Tri-State Title & Escrow, LLC, the "Escrow Agent,” the Company was required to deposit with the Escrow Agent $5,500,000 immediately on the Closing Date of the Share Purchase Agreement. This fund can only be disbursed when certain criteria are met. As of December 31, 2010 and June 30, 2010, the undisbursed amounts were $0 and $206,604, respectively.  On August 25, 2010, after full compliance with the Escrow Agreement, a total amount of $ 207,216 was released from the Escrow account under Tri-State Title & Escrow, LLC., and the Escrow account was closed.

Accounts receivable
 
In the normal course of business, the Company extends credit to its customers without requiring collateral or other security interests.  Management reviews its accounts receivables at each reporting period to provide for an allowance against accounts receivable for an amount that could become uncollectible. This review process may involve the identification of payment problems with specific customers. The Company estimates this allowance based on the aging of the accounts receivable, historical collection experience, and other relevant factors, such as changes in the economy and the imposition of regulatory requirements that can have an impact on the industry. These factors continuously change, and can have an impact on collections and the Company’s estimation process. These impacts may be material. Certain accounts receivable amounts are charged off against allowances after designated period of collection efforts. Subsequent cash recoveries are recognized as income in the period when they occur. The allowance for doubtful accounts amounted to $2,211,523 and $1,306,268 as of December 31, 2010 and June 30, 2010, respectively.

 
9

 

Concentrations of risk

The Company's operations are in the PRC. Accordingly, the Company's business, financial condition and results of operations may be influenced by the political, economic and legal environments in the PRC, and by the general state of the PRC's economy. The Company's operations in the PRC are subject to specific considerations and significant risks not typically associated with companies in North America and Western Europe. These include risks associated with, among others, the political, economic and legal environments and foreign currency exchange. The Company's results may be adversely affected by changes in governmental policies with respect to laws and regulations, anti-inflationary measures, currency conversion and remittance abroad, and rates and methods of taxation, among others.
 
Management believes the credit risk on bank deposits is limited because the counterparties are banks with high credit-ratings assigned by international credit-rating agencies, or state-owned banks in China. Cash includes cash on hand and demand deposits in accounts maintained with state-owned banks within the PRC and the United States of America. The cash deposits in U.S. financial institutions exceed the amounts insured by the U.S. government. Balances at financial institutions or state owned banks within the PRC are not covered by insurance. Non-performance by these institutions could expose the Company to losses for amounts in excess of insured balances. At December 31, 2010 and June 30, 2010, the Company’s bank balances exceeded government insured limits or not covered by insurance by approximately $10,409,470 and $20,470,585, respectively. The Company has not experienced, nor does it anticipate, nonperformance by these institutions.

The Company’s concentrations of credit risk are primarily in trade accounts receivable and accounts payable. For the three and six months ended December 31, 2010 and 2009, there were no customers that individually comprised 10% or more of the Company’s total revenues. For the three and six months ended December 31, 2010 and 2009, there were no vendors that individually accounted for over 10% or more of the Company’s total purchases.

For export sales, we frequently require significant down payments or letter of credit by our customers prior to shipment. During the year, the Company maintains export credit insurance to protect the Company against the risk that the overseas customers may default on settlement.

The following table summarizes financial information for the three and six months ended December 31, 2010 and 2009, concerning the Company’s revenues based on geographic area:

For the three months ended:

 
December 31,
2010
 
December 31,
2009
 
  
 
(Unaudited)
 
(Unaudited)
 
           
China
  $ 40,835,070     $ 21,363,310  
                 
International
    8,209,786       7,145,549  
                 
Total
  $ 49,044,856     $ 28,508,859  
 
 
10

 


Revenue 
 
December 31,
2010
 
December 31,
2009
 
   
(Unaudited)
 
(Unaudited)
 
           
China
  $ 69,498,700     $ 41,402,386  
                 
International
    14,190,728       10,233,530  
                 
Total
  $ 83,689,428     $ 51,635,916  


Inventories are stated at the lower of cost (weighted average basis) or market and consist of the following:
  
  
 
December 31,
2010
   
June 30,
2010
 
  
 
(Unaudited)
       
             
Raw materials
  $ 10,027,917     $ 2,739,503  
                 
Work-in-progress
    4,613,152       4,343,957  
                 
Finished goods
    1,898,194       3,988,710  
                 
Total
  $ 16,539,263     $ 11,072,170  
   
The Company reviews its inventory periodically for possible obsolete goods or to determine if any reserves are necessary. As of December 31, 2010, the Company has determined that no reserves are necessary.

Prepayments

Prepayments represent partial payments or deposits for inventory purchases. These advances are interest free and unsecured.
 
Advance for construction

Advance for construction represent advance for construction. As of December 31, 2010 and June 30, 2010, the advance for construction amounted to $1,349,722 and $2,334,748. Advance for construction are paid to unrelated parties, interest free, and with no collateral and no guarantee.

Plant and equipment

Plant and equipment are stated at cost less accumulated depreciation. Additions and improvements to property and equipment accounts are recorded at cost. Maintenance, repairs, and minor renewals are charged directly to expense as incurred. Major additions and betterments to property and equipment accounts are capitalized. Depreciation is computed using the straight-line method over the estimated useful lives of the assets with 3% residual value.

 
11

 

Estimated useful lives of the assets are as follows:

 
Estimated Useful Life
   
Buildings
 
5-20
 
Years
         
Machinery and equipment
 
5-10
 
Years
         
Automobile facilities
 
5-10
 
Years
         
Electronic equipment
 
5-7
 
Years
  
Long-lived assets of the Company are reviewed at least annually or more often if circumstances dictate, to determine whether their carrying value has become impaired. The Company considers assets to be impaired if the carrying value exceeds the future projected cash flows- from related operations. The Company also re-evaluates the periods of depreciation to determine whether subsequent events and circumstances warrant revised estimates of useful lives. As of December 31, 2010, the Company expects these assets to be fully recoverable.

Investment in unconsolidated affiliate

Equity method investments are recorded at original cost and adjusted to recognize the Company’s proportionate share of the investee’s net income or losses and additional contributions made and distributions received. The Company recognizes a loss if it is determined that other than temporary decline in the value of the investment exists.

Intangible assets

Intangible assets consist of the following:
  
   
December 31,
2010
   
June 30,
2010
 
   
(Unaudited)
       
Land use rights:
  $ 3,554,723     $ 3,451,619  
Less: accumulated amortization
    (343,381 )     (306,261 )
Land use rights, net
    3,211,342       3,145,385  
                 
Software
    8,022       7,789  
Less: accumulated amortization
    (2,774 )     (2,254 )
Software, net
    5,248       5,536  
Total intangible assets, net
  $ 3,216,590     $ 3,150,894  

Intangible assets are primarily comprised of land use rights which are pledged as collateral for bank loans as of December 31, 2010. All land in the PRC is owned by the Chinese government. However, the government grants “land use rights” for terms ranging from 20 to 50 years. From March 2000 to June 2008, the Company acquired various land use rights for approximately $3,291,000. From July 2008 to March 2009, the Company acquired various land use rights for approximately $480,520. The Company amortizes the cost of land use rights over the usage terms using the straight-line method.
  
In April 2009, the Company sold a land use right. At the time of the sale, the net book value of the land use right was $348,491, and the sale price for the land use right was $879,000, for a gain of approximately $530,509. As of December 31, 2010, total proceeds had been received.

In August 2009, the Company increased one land use right by paying to the government approximately $43,434 for expenses related to processing the land certificate.

 
12

 

Intangible assets are reviewed at least annually and more often if circumstances dictate, to determine whether their carrying value has become impaired. The Company considers assets to be impaired if the carrying value exceeds the future projected cash flows from related operations. The Company also re-evaluates the periods of amortization to determine whether subsequent events and circumstances warrant revised estimates of useful lives. As of December 31, 2010, the Company determined that there had been no impairment. Total amortization expense for the six months ended December 31, 2010 and 2009 amounted to $27,949 and $28,164 respectively. Total amortization expense for the three months ended December 31, 2010 and 2009 amounted to $14,205 and $14,257 respectively. 

The following table consists of the expected amortization expenses for the next five years:
  
 
Amount
 
2011
  $ 56,000  
2012
    56,000  
2013
    56,000  
2014
    56,000  
2015
    56,000  
Thereafter
    2,936,590  
Total
  $ 3,216,590  
  
Income taxes

The Company accounts for income taxes in accordance with ASC 740 (Originally issued SFAS 109, “Accounting for Income Taxes.”) Under the asset and liability method as required by ASC 740 (Originally issued SFAS 109), deferred income taxes are recognized for the tax consequences of temporary differences by applying enacted statutory tax rates applicable to future years to differences between the financial statement carrying amounts and the tax bases of existing assets and liabilities. Under ASC 740, the effect on deferred income taxes of a change in tax rates is recognized in income in the period that includes the enactment date. A valuation allowance is recognized if it is more likely than not that some portion, or all of, a deferred tax asset will not be realized. As of December 31, 2010and June 30, 2010, the Company did not have any deferred tax assets or liabilities, and as such, no valuation allowances were recorded at December 31, 2010 and June 30, 2010.

ASC 740 (Originally issued FIN 48) clarifies the accounting and disclosure for uncertain tax positions and prescribes a recognition threshold and measurement attribute for recognition and measurement of a tax position taken or expected to be taken in a tax return. ASC 740 also provides guidance on de-recognition, classification, interest and penalties, accounting in interim periods, disclosure and transition.

Under ASC 740, evaluation of a tax position is a two-step process. The first step is to determine whether it is more-likely-than-not that a tax position will be sustained upon examination, including the resolution of any related appeals or litigation based on the technical merits of that position. The second step is to measure a tax position that meets the more-likely-than-not threshold to determine the amount of benefit to be recognized in the financial statements. A tax position is measured at the largest amount of benefit that is greater than 50 percent likely of being realized upon ultimate settlement. Tax positions that previously failed to meet the more-likely-than-not recognition threshold should be recognized in the first subsequent period in which the threshold is met. Previously recognized tax positions that no longer meet the more-likely-than-not criteria should be de-recognized in the first subsequent financial reporting period in which the threshold is no longer met.
  
The Company’s operations are subject to income and transaction taxes in the United States and in the PRC jurisdictions. Significant estimates and judgments are required in determining the Company’s worldwide provision for income taxes. Some of these estimates are based on interpretations of existing tax laws or regulations, and as a result the ultimate amount of tax liability may be uncertain. However, the Company does not anticipate any events that would lead to changes to these uncertainties.

 
13

 

Value Added Tax

Enterprises or individuals who sell products, engage in repair and maintenance or import and export goods in the PRC are subject to a value added tax in accordance with Chinese laws. The standard value added tax rate is 17% of the gross sales price, however, for the Company’s corn, the VAT rate is 13%. A credit is available whereby VAT paid on the purchases of semi-finished products, raw materials used in the production of the Company’s finished products, and payment of freight expenses can be used to offset the VAT due on sales of the finished products.

VAT on sales and VAT on purchases amounted to $6,443,295 and $6,216,854 for the three months ended December 31, 2010, and  $2,969,214 and $2,954,912 for the three months ended December 31, 2009, respectively. VAT on sales and VAT on purchases amounted to $10,955,557 and $10,776,688 for the six months ended December 31, 2010, and  $6,398,113 and $6,225,475 for the six months ended December 31, 2009, respectively. Sales and purchases are recorded net of VAT collected and paid as the Company acts as an agent for the government. VAT taxes are not impacted by the income tax holiday in the PRC.

Guarantees

From time to time, the Company guarantees the debt of others unrelated to the Company. Pursuant to ASC 460 (Formerly FIN 45, “Guarantor’s Accounting for and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness to Others,”) the Company must record guarantees at the fair value of the expected future payments. However, the Company estimates that it will not be required to make any payments under these guarantees based on the past experience and the financial condition of the companies to which the guarantees were made.

Recently issued accounting pronouncements
 
In October 2009, the FASB issued Accounting Standards Update, 2009-13, Revenue Recognition (Topic 605): Multiple Deliverable Revenue Arrangements - A Consensus of the FASB Emerging Issues Task Force.” This update provides application guidance on whether multiple deliverables exist, how the deliverables should be separated and how the consideration should be allocated to one or more units of accounting. This update establishes a selling price hierarchy for determining the selling price of a deliverable. The selling price used for each deliverable will be based on vendor-specific objective evidence, if available, third-party evidence if vendor-specific objective evidence is not available, or estimated selling price if neither vendor-specific or third-party evidence is available. The Company will be required to apply this guidance prospectively for revenue arrangements entered into or materially modified after January 1, 2011; however, earlier application is permitted. Management is in the process of evaluating the impact of adopting this ASC update on the Company’s financial statements.

In January 2010, the FASB issued Accounting Standards Update No. 2010-06 (ASU 2010-06), Fair Value Measurements and Disclosures which amends ASC Topic 820, adding new requirements for disclosures for Levels 1 and 2, separate disclosures of purchases, sales, issuances, and settlements relating to Level 3 measurements and clarification of existing fair value disclosures. ASU 2010-06 is effective for interim and annual periods beginning after December 15, 2009, except for the requirement to provide Level 3 activity of purchases, sales, issuances, and settlements on a gross basis, which will be effective for fiscal year beginning after December 15, 2010 (the Company’s fiscal year 2011); early adoption is permitted. The Company is currently evaluating the impact of adopting ASU -2010-06 on its financial statements.

In July 2010, the FASB issued Accounting Standards Update (ASU) No. 2010-20, “Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses” ASU No. 2010-20 amends the guidance with ASC Topic 310, “Receivables” to facilitate financial statement users’ evaluation of (1) the nature of credit risk inherent in the entity’s portfolio of financing receivables; (2) how that risk is analyzed and assessed in arriving at the allowance for credit losses; and (3) the changes and reasons for those changes in the allowance for credit losses. The amendments in ASU No. 2010-20 also require an entity to provide additional disclosures such as a rollforward schedule of the allowance for credit losses on a portfolio segment basis, credit quality indicators of financing receivables and the aging of past due financing receivables. The adoption of ASU No. 2010-20 did not have an impact on the financial statements and footnotes.

 
14

 


Plant and equipment consist of the following:

  
 
December 31,
2010
   
June 30,
2010
 
  
 
(Unaudited)
       
Buildings
  $ 23,242,508     $ 22,028,136  
                 
Machinery and equipment
    65,419,377       65,019206  
                 
Automobile facilities
    636,271       656,544  
                 
Electronic equipment
    585,072       527,609  
                 
Construction in progress
    16,023,962       10,533,083  
                 
Total
    105,907,190       98,764,578  
                 
Accumulated depreciation
    (25,645,654 )     (23,390,727 )
                 
Total
  $ 80,261,536     $ 75,373,851  
   
Construction-in-progress represents the costs incurred in connection with the construction of buildings or new additions to the Company’s plant facilities. No depreciation is provided for construction-in-progress until such time as the assets are completed and placed into service. Depreciation expense for the three months ended December 31, 2010 and 2009 amounted to $1,665,369 and $1,912,106, respectively. Interest costs totaling $422,571 and $65,371 were capitalized into construction-in-progress for the three months ended December 31, 2010 and 2009, respectively. Depreciation expense for the six months ended December 31, 2010 and 2009 amounted to $3,560,415 and $3,830,468, respectively. Interest costs totaling $422,571 and $78,468 were capitalized into construction-in-progress for the six months ended December 31, 2010 and 2009, respectively.
   
Note 4 - Investment in unconsolidated affiliate

On September 16, 2003, the Company entered into a joint venture partnership with Weifang City Investment Company and Changle Century Sun Paper Industry Co., Ltd, and formed Changle Shengshi Redian Co., Ltd (“Changle Shengshi”). Changle Shengshi was incorporated in Weifang City, Shandong Province, PRC. Changle Shengshi’s principal activity is to produce and sell electricity and heat. The Company accounts for this 20% investment under the equity method of accounting.
 
Summarized unaudited financial information of Changle Shengshi is as follows:

 
December 31,
   
June 30,
 
  
 
2010
   
2010
 
   
(unaudited)
   
(unaudited)
 
Current assets
  $ 28,535,090     $ 24,083814  
                 
Non-current assets
    63,132,192       51,248,756  
                 
Total assets
    91,667,282       75,332,569  
                 
Current liabilities
    58,048,450       43,098,908  
                 
Non-current liabilities
    596,350       1,164,071  
                 
Shareholders' equity
    33,022,482       31,069,590  
                 
Total liabilities and shareholders' equity
  $ 91,667,282     $ 75,332,569  

 
15

 

Summarized financial information of Changle Shengshi for the six months ended December 31, 2010 and 2009 is as follows:

   
December 31,
 
   
2010
   
2009
 
   
(unaudited)
   
(unaudited)
 
Net sales
  $ 33,949,108     $ 24,602,890  
                 
Gross profit
  $ 4,074,735     $ 4,435,025  
                 
Income before taxes
  $ 1,948,723     $ 3,295,270  
                 
Net income
  $ 1,461,542     $ 2,464,121  
                 
Percentage of ownership
    20 %     20 %
                 
Company share of income
  $ 292,308     $ 492,824  
                 
Elimination of intercompany profit
  $ 61,176     $ (145,715  
                 
Company’s share of net income
  $ 231,133     $ 347,109  

Note 5 - Related party transactions

The Company’s utilities are mostly provided by Changle Shengshi (See Note 4). As of December 31, 2010 and June 30, 2010, the Company’s accounts payable due to Changle Shengshi was approximately $1,061,947 and $252,017, respectively, which related to a portion of the Company’s utilities being provided by Changle Shengshi. The utilities expense amounted to approximately $3,518,879 and $2,664,024 for the three months ended December 31, 2010 and 2009, respectively. The utilities expense amounted to approximately $7,170,278 and $7,242,471 for the six months ended December 31, 2010 and 2009, respectively.


Short term loans

Short term loans represent amounts due to various banks which are normally due within one year, and these loans can be renewed with the banks. The Company’s short term bank loans consisted of the following:

 
16

 

   
 
December 31,
2010
   
June 30,
2010
 
   
(Unaudited)
       
Loans from Bank of China, due various dates from February 2010 to June 2011; monthly interest only payments; interest rates are 5.5755% per annum, guaranteed by an unrelated party and secured by certain properties.  
  $ 15,170,000     $ 14,730,000  
   
               
Loans from Industrial and Commercial Bank of China, due various dates from February 2010 to June 2011; monthly interest only payments; interest rate ranging from 5.31% to 6.372% per annum, guaranteed by an unrelated third party and secured by certain properties.  
    11,013,420       9,662,880  
   
               
Loan from Agriculture Bank of China, due from June 2010 to December 2011; monthly interest only payments; interest rates ranging from 5.841% to 6.116% per annum, guaranteed by an unrelated third party, unsecured
    7,585,000       8,838,000  
                 
Loan from China Merchants Bank, due from October 2010 to October 2011, monthly interest only payments; interest rate of 5.56% per annum, secured by certain properties.
    3,034,000       -  
                 
Loan from Qingdao Bank, due from December  2010to December 2011, monthly interest only payments; interest ratesare 6.116% per annum, guaranteed by an unrelated third party, unsecured
    3,034,000       2,946,000  
   
               
Loan from Minsheng Bank, due from September 2010 to September 2011; monthly interest only payments; interest rate of 5.841% per annum, guaranteed by an unrelated third party, unsecured.  
    1,517,000       -  
                 
Loan from Zhongxin Bank, due March 2011, monthly interest only payments; interest rates ranging from 5.61% to 6.116% per annum, guaranteed by an unrelated third party, unsecured
    3,034,000       3,240,600  
                 
Loan from Shenzhen Development Bank, due March 2011, monthly interest only payments; interest rate of 5.5755% per annum, guaranteed by an unrelated third party, unsecured
    3,337,400       3,240,600  
                 
Loan from Dezhi Zheng, an individual, from March 5, 2010 to March 4, 2011; monthly interest of 0.7%; principal and interest payments due on March 4, 2011; guaranteed by Mr. Qingtai Liu
    -       736,500  
   
               
Total  
  $ 47,724,820     $ 40,153,980  
   

Notes payable represent amounts due to various banks which are normally due within one year, and these notes can be renewed with the banks. The Company’s notes payables consisted of the following:
 
   
December 31,
2010
   
June 30,
2010
 
   
(Unaudited)
       
Weifang Bank, due from October 2010 to June 2011, 0.05% transaction fee, restricted cash required 50% of loan amount, guaranteed by an unrelated third party.  
  $ 6,068,000     $ -  
                 
Bank of China, due on various dates from November 2009 to April 2010, 0.05% transaction fee, and restricted cash required 50% to 100% of loan amount, guaranteed by an unrelated third party.  
    -       8,383,000  
                 
Industrial and Commercial Bank of China, due on various dates from August to October 2009, 0.05% transaction fee, restricted cash required 50% of loan amount, guaranteed by an unrelated third party.  
    -       1,767,600  
                 
Industrial and Commercial Bank of China, due from September 2010 to March 2011, 0.05% transaction fee, restricted cash required 50% of loan amount, guaranteed by an unrelated third party.  
    1,213,600       1,178,400  
                 
Bank of Qingdao, due in July 2010, 0.05% transaction fee, and restricted cash required 100% of loan amount, guaranteed by an unrelated third party.
    -       2,946,000  
                 
Loan from Shenzhen Development Bank, due from March 2010 to September 2010, 0.05% transaction fee, and restricted cash required for 100% of loan amount, and guaranteed by an unrelated third party.
    -       3,039,300  
                 
Total
  $ 7,281,600     $ 17,823,300  

 
17

 

Employee loans

From time to time, the Company borrows monies from certain employees for cash flow purposes. These loans do not require collateral, and the principal is due upon demand. Before January 1, 2009, the interest rate was at 7.2% for the first six months, and then 10.8% thereafter until the full principal amounts are paid by the Company. After January 1, 2009, the interest rate was changed to 7.2% for the loan period. Employee loans amounted to $385,339 and $396,404 as of December 31, 2010 and June 30, 2010, respectively. Interest expense related to these loans amounted to $0 and $18,700 for the six months ended December 31, 2010, and 2009, respectively. Interest expense related this loan was de minimis for the three and six months ended December 31, 2010, and 2009, respectively.

Employee loan - officer

From time to time, the Company borrows monies from Qingtai Liu, The Company’s CEO and President for cash flow purposes of the Company. The loan does not require collateral and the principal is due upon demand. Before January 1, 2009, the interest rate was at 7.2% for the first six months, and then 10.8% thereafter until the full principal amounts are paid by the Company. After January 1, 2009, the interest rate was changed to 7.2% for the loan period. Employee loan from officer amounted to $531,116 and $515,856 as of December 31, 2010 and June 30, 2010, respectively. Interest expense related this loan was de minimis for the three and six months ended December 31, 2010, and 2009, respectively.

Third party loan

From time to time, the Company borrows money from unrelated third parties for use in operations. The loan does not require collateral, interest free, and the principal is due upon demand. Balances as of December 31, 2010 and June 30, 2010 were $341,325 and $0, respectively. Interest expense related this loan was de minimis for the three and six months ended December 31, 2010, and 2009, respectively.

Interest

Total interest expense and financial charges, net of capitalized interest, for the three months ended December 31, 2010 and 2009 on all debt, amounted to $427,576 and $913,532, respectively. Interest capitalized into construction-in-progress totaled $422,571,and $0 for the three months ended December 31, 2010 and 2009, respectively. Total interest expense and financial charges, net of capitalized interest, for the six months ended December 31, 2010 and 2009 on all debt, amounted to $1,550,692 and $1,642,318, respectively. Interest capitalized into construction-in-progress totaled $422,571 and $13,097 for the six months ended December 31, 2010 and 2009, respectively. 

 
18

 

Note 7 - Income taxes

Before January 1, 2008, the Company was governed by the Income Tax Law of the PRC concerning Foreign Investment Enterprises (“FIEs”) and Foreign Enterprises and various local income tax laws (the “Income Tax Laws”). Under the Income Tax Laws, FIEs are generally subject to an effective income tax of 33% (30% state income taxes plus 3% local income taxes) on income as reported in their statutory financial statements after appropriate tax adjustments, unless the enterprise is located in specially designated regions of cities for which more favorable effective tax rates apply.

In February 2004, the Company became a Sino-foreign joint venture. In August 2004, the state government granted the Company income tax exemptions as follows: 100% exemption for the first two years from September 2004 to August 2006, and 50% exemption for three years from September 2006 to August 2009. In addition, the Company is located in a Special Economic Zone and the PRC tax authority has offered it with a special income tax rate of 24%. With the approval of the local government, the Company is subject to income taxes at a reduced rate of 12% from September 2006 to August 2009, after the two-year 24% exemption for income taxes until its exemption and reduction periods expire in August 2009.

Beginning on January 1, 2008, the new Enterprise Income Tax (“EIT”) law replaced the existing laws for Domestic Enterprises (“DES”) and Foreign Investment Enterprises.

The key changes are:

a.
The new standard EIT rate of 25% will replace the 33% rate currently applicable to both DES and FIEs, except for High Tech companies who pays a reduced rate of 15%;

b.
Companies established before March 16, 2007 will continue to enjoy tax holiday treatment approved by local government for a grace period of the next 5 years or until the tax holiday term is completed, whichever is sooner.
 
The Company’s subsidiary, Weifang Shengtai was established before March 16, 2007, and therefore is qualified to continue to be taxed at the reduced rate as described above until the tax holiday term is completed. Starting on September 1, 2009, the Company was subject to a 25% income tax rate pursuant to the new income tax laws. During the six months ended December 31, 2010 and 2009, the provision for income taxes was $1,524,397 and $562,862, respectively. During the three months ended December 31, 2010 and 2009, the provision for income taxes was $846,940 and $474,964, respectively.

The following table reconciles the U.S. statutory rates to the Company’s effective tax rate for the six months ended December 31:

   
2010
   
2009
 
   
(Unaudited)
   
(Unaudited)
 
             
U.S. Statutory rates
    34.0 %     34.0 %
                 
Foreign income not recognized in USA
    (34.0 )     (34.0 )
                 
China income taxes
    25.0       25.0  
                 
China income exemption (a)
    -       (7.0 )
                 
Other items (b)
    1.0       5.0  
                 
Total provision for income taxes
    26.0 %     23.0 %

 
19

 

(a)
The 7% represents the special tax credits from the local government due to government enforced regulation that expired in September 2009.
(b)
Other item is for operating expenses incurred by Shengtai that are not deductible in the PRC and expenses incurred by other subsidiaries that are not deductible on the consolidated level, which resulted in change in effective tax rate of (1% and 5% for the six months ended December 31, 2010 and 2009, respectively.)
 
The estimated tax savings for the three months ended December 31, 2010 and 2009 amounted to $0  and $0, respectively. The net effect on basic earnings per share if the income tax had been applied would decrease basic earnings per share for the three months ended December 31, 2010 and 2009 by $0.00 and $0.00, respectively. The net effect on diluted earnings per share if the income tax had been applied would decrease diluted earnings per share for the three months ended December 31, 2010 and 2009 by $0.00 and $0.00, respectively. The estimated tax savings for the six months ended December 31, 2010 and 2009 amounted to $0 and $239,803, respectively. The net effect on basic earnings per share if the income tax had been applied would decrease basic earnings per share for the six months ended December 31, 2010 and 2009 by $0.00 and $0.01, respectively. The net effect on diluted earnings per share if the income tax had been applied would decrease diluted earnings per share for the six months ended December 31, 2010 and 2009 by $0.00 and $0.01, respectively.

Shengtai Pharmaceutical, Inc. and Shengtai Holding, Inc. were incorporated in the United States and have incurred estimated net operating loss for income tax purposes for 2011..The estimated net operating loss carry forwards for United States income taxes amounted to $2,475,103 which may be available to reduce future years’ taxable income. These carry forwards will expire, if not utilized, from 2027 through 2030.  Management believes that the realization of the benefits from these losses appears uncertain due to the Company’s limited operating history and continuing losses for United States income tax purposes.  Accordingly, the Company has provided a 100% valuation allowance on the deferred tax benefit to reduce the asset to zero. The valuation allowance at December 31, 2010 amounted to $841,535.

The Company has cumulative undistributed earnings of foreign subsidiaries of approximately $35,588,675 as of December 31, 2010, is included in consolidated retained earnings and will continue to be indefinitely reinvested in international operations. Accordingly, no provision has been made for U.S. deferred taxes related to future repatriation of these earnings, nor is it practicable to estimate the amount of income taxes that would have to be provided if the Company concluded that such earnings will be remitted in the future.

Taxes payable

Taxes payable consisted of the following:  
  
   
December 31,
2010
   
June 30,
2010
 
   
(Unaudited)
       
VAT payable
  $ 322,818     $ 1,622,859  
                 
Individual income tax withheld
    18,072       423  
                 
Income tax payable
    286,578       387,299  
                 
Housing property tax payable
    17,399       10,098  
                 
Others
    55,305       46,199  
                 
Total taxes payable
  $ 700,172     $ 2,066,878  

 
20

 

Note 8 - Commitments and Contingent liabilities

Guarantees

As of December 31, 2010, the Company has guaranteed $4.5 million short term loans for an unrelated party, Yuanli Chemical Engineering Inc. (“Yuanli”).

The Company is obligated to perform under the guarantee if Yuanli fails to pay principal and interest payments when due. The maximum potential amount of future undiscounted payments under the guarantee are about $4.8 million for Yuanli, including accrued interests. The Company did not record a liability for the guarantee because management knows Yuanli is current in its payment obligations, and the likelihood of the Company having to make good on the guarantee is remote.
  
Detail of guarantee amount to the unrelated party as of December 31, 2010 is as follows:

   
Short Term
 
Company
 
Bank Loans
 
       
Yuanli Chemical Engineering Inc.
  $ 4,551,000  
         
Total
  $ 4,551,000  
 
Litigation
  
In the Company’s ordinary course of business, the Company may be subject to certain legal proceedings. After review and consultation with the Company’s legal counsel, management believes that the outcome of the legal matters will not have a materially adverse effect on the consolidated results of operations or consolidated financial position of the Company.
 
Note 9 - Shareholders’ equity

On November 9, 2010, the Company effected a 1-for-2 reverse stock split of its issued and outstanding shares of Common Stock; reducing the number of its authorized shares of Common Stock and Preferred Stock by the same reverse stock split ratio.  The reverse stock split and the reduction of the number of authorized shares of Common Stock and Preferred Stock were authorized by the stockholders of the Company at its annual general meeting of stockholders held on October 26, 2010.  As of November 12, 2010, the outstanding and issued shares were approximately 9,584,903 shares (prior to the reverse stock split the number outstanding was 19,169,805), before rounding up fractional shares.  The authorized number of shares of Common Stock was reduced from 100,000,000 to 50,000,000, and the authorized number of shares of Preferred Stock was reduced from 5,000,000 to 2,500,000.  These financial statements have been adjusted retroactively to reflect the reverse stock split.

Warrants

On May 15, 2007, in connection with the Share Purchase Agreement, the 4,375,000 warrants (“Investor Warrants”) carry an exercise price of $2.60 and a 5-year term. The Investor Warrants are callable if the Company’s shares trade at or above $8.00 per share for 20 consecutive trading days and underlying shares are registered for resale. The Investor Warrants contain standard adjustment provisions upon stock dividend, stock split, stock combination, recapitalization, and a change of control transaction. During the year ended June 30, 2008, a total of 194,805 warrants were exercised from three shareholders.

 
21

 

Also in connection with the Share Purchase Agreement, the Company issued 218,750 warrants (“Placement Agent Warrants”) to Brill Securities, the Placement Agent. These Placement Agent Warrants have the same terms as the Investor Warrants. These warrants were issued on August 8, 2007.
  
Concurrent with the offering related to the Share Purchase Agreement, the Company issued 75,000 warrants to Chinamerica Fund, LLP and 25,000 warrants to Jeff Jenson (collectively, the “Lead Investor Warrants”) to compensate Chinamerica Fund LLP as the lead investor and for Jeff Jenson in assisting in providing the shell company, West Coast Car Company. These Lead Investor Warrants have the same terms as the Investor Warrants except that they have an exercise price of $0.01 per share. In June 2008, Jeff Jenson exercised the 25,000 warrants issued to him. In November 2008, Chinamerica Fund, LLP exercised the 75,000 warrants issued to the fund.

All Investor Warrants, Placement Agent Warrants, and Lead Investor Warrants meet the conditions for equity classification pursuant to ASC 815 (Originally issued SFAS No. 133 “Accounting for Derivatives”) and ASC 815 (Originally issued EITF 00-19), “Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company's Own Stock.” Therefore, these warrants were classified as equity and accounted for as common stock issuance cost.

 
Warrants
Outstanding
   
Warrants
Exercisable
   
Weighted
Average
Exercise
Price
   
Average Remaining
Contractual
Life
 
Outstanding, June 30, 2009
    4,398,945       4,398,945     $ 2.60       2.97  
                                 
Granted
    -       -       -       -  
                                 
Forfeited
    -       -       -       -  
                                 
Exercised
                            -  
                                 
Outstanding, June 30, 2010
    4,398,945       4,398,945     $ 2.60       2.22  
                                 
Granted
    -       -       -       -  
                                 
Forfeited
    -       -       -       -  
                                 
Exercised
    -       -       -       -  
                                 
Outstanding, December 31, 2010 (unaudited)
    4,398,945       4, 398,945     $ 2.60       1.72  

Stock options

On January 4, 2008, the Company adopted “Shengtai Pharmaceutical, Inc. 2007 Stock Incentive Plan” (the “Stock Incentive Plan”). The Company believes that such awards better align the interests of its employees with those of its shareholders. Option awards are generally granted with an exercise price equal to the fair value of the Company’s stock at the date of grant.
 
On May 14, 2008, the Company granted 500,000 stock options and 160,000 non-qualified stock options pursuant to the Stock Incentive Plan. All options have an exercise price of $3.34, which is the closing price on the date of grant, and expire five years after the date of grant. All options vest over a period of three years on a quarterly basis from the date of grant.

 
22

 

The Company uses the Black-Scholes option pricing model which was developed for use in estimating the fair value of options. Option pricing models require the input of highly complex and subjective variables including the expected life of options granted and the Company’s expected stock price volatility over a period equal to or greater than the expected life of the options. Because changes in the subjective assumptions can materially affect the estimated value of the Company’s employee stock options, it is management’s opinion that the Black-Scholes option valuation model may not provide an accurate measure of the fair value of the Company’s employee stock options. Although the fair value of employee stock options is determined in accordance with SFAS 123R using an option pricing model, that value may not be indicative of the fair value observed in a willing buyer/willing seller market transaction.
 
The assumptions used in calculating the fair value of options granted using the Black-Scholes option pricing model are as follows:

    3.22 %
         
Expected term
 
4 years
 
         
Expected volatility
    146 %
         
Expected dividend yield
    0 %
         
Weighted average grant-date fair value per option
  $ 3.34  

The volatility of the Company’s common stock was estimated by management based on the historical volatility; the risk free interest rate was based on Treasury Constant Maturity Rates published by the U.S. Federal Reserve for periods applicable to the estimated life of the options; and the expected dividend yield was based on the current and expected dividend policy. The fair value of the options was based on the Company’s common stock price on the date the options were granted. ASC 718 (Originally issued SFAS 123R) allows use of the “simplified” method to determine the term when other information is not available. Because the Company does not have sufficient applicable history of employee stock options activity, the Company uses the simplified method to estimate the life of the options by taking the sum of the vesting period and the contractual life and then calculating the midpoint which is the estimated term of the options.
 
In the Chief Financial Officer Employment Agreement entered into on March 1, 2010 between the Company and Mr. Hu Ye, the Chief Financial Officer, the Company granted Mr. Hu Ye an option to purchase 300,000 shares of common stock of the Company.  The shares vest over 3 years starting March 1st, 2010 and terminating on the third anniversary of the date of issuance of this option.  The Company valued the shares at $2.60 per share, which represents 130% of the fair market value being calculated in the private placement price on May 15th, 2007. The fair values of stock options granted to the CFO were estimated at the date of grant using the Black-Scholes option-pricing model with the following assumptions:

Weighted average risk-free interest rate
    2.79 %
         
Expected term
 
6.5 years
 
         
Expected volatility
    149 %
         
Expected dividend yield
    0 %
         
Weighted average grant-date fair value per option
  $ 2.60  

The Company terminated the Chief Financial Officer Employment Agreement between the Company and Mr. Hu Ye in December 2010, and the 300,000 options granted were forfeited.

 
23

 

The stock option activity was as follows:  

 
Options
outstanding
   
Weighted
Average
Exercise
Price
   
Aggregate
Intrinsic
Value
 
Outstanding, June 30, 2009
    660,000     $ 3.34     $    
                         
Granted
    300,000       2.60       -  
                         
Forfeited
    (275,000 )     3.34       -  
                         
Exercised
    -       -       -  
                         
Outstanding, June 30, 2010
    685,000     $ 3.02     $ -  
                         
Granted
    -       -       -  
                         
Forfeited
    (335,000 )     2.60       -  
                         
Exercised
    -       -       -  
                         
    350,000     $ 3.34     $ -  

Following is a summary of the status of options outstanding at December 31, 2010:  
 
Average
Exercise  Price
 
Outstanding
Options
   
Average
Remaining
Contractual  Life
   
Average
Exercise  Price
   
Exercisable
Options
 
 3.34
    350,000       2.37     $ 3.34       350,000  

For the three and six months ended December 31, 2010, $83,304 and $183,480 were expensed and recorded as compensation expense in the Company’s income statements, respectively. For the three and six months ended December 31, 2009, $158,818 and $317,636 were expensed as compensation expense in the Company’s income statements.

Note 10 - Statutory reserves

The laws and regulations of the PRC require that before a Sino-foreign cooperative joint venture enterprise distributes profits to its partners, it must first satisfy all tax liabilities, provide for losses in previous years, and make allocations in proportions determined at the discretion of the board of directors, after the statutory reserves. The statutory reserves include the surplus reserve fund, and the enterprise fund. These statutory reserves represent restricted retained earnings.
 
Surplus reserve fund

The Company is required to transfer 10% of its net income, as determined in accordance with the PRC accounting rules and regulations, to a statutory surplus reserve fund until such reserve balance reaches 50% of the Company’s registered capital.

 
24

 

The transfer to this reserve must be made before distribution of any dividends to shareholders. For the three months ended December 31, 2010 and 2009, the Company transferred $457,319 and $142,055 to this reserve respectively. For the six months ended December 31, 2010 and 2009, the Company transferred $457,319 and $264,780 to this reserve respectively. The surplus reserve fund is non-distributable other than during liquidation and can be used to fund previous years’ losses, if any, and may be utilized for business expansion or converted into share capital by issuing new shares to existing shareholders in proportion to their shareholding or by increasing the par value of the shares currently held by them, provided that the remaining reserve balance after such issue is not less than 25% of the registered capital.

Pursuant to the Company’s articles of incorporation, the Company is to appropriate 10% of its net profits as statutory surplus reserve up to $7,500,000. As of December 31, 2010 the Company had appropriated to the statutory reserve approximately $3,672,000. The Company plans to contribute $3,828,000 in the future.

Enterprise fund

The enterprise fund may be used to acquire fixed assets or to increase the working capital to expend on production and operation of the business. No minimum contribution is required and the Company has not made any contribution to this fund.

Note 11 – Sale Leaseback

Capital lease
 
On December 10, 2008, the Company entered into a sale leaseback arrangement and sold part of its equipment to an unrelated third party for approximately $5,134,500. The leaseback has been accounted for as a capital lease with the same third party to lease the same equipment for 4 years, with total payments of approximately $8,119,845. The title of the equipment will be transferred back to the Company upon the last payment and after the third party receives a one time payment of $44,010 from the Company. A one time processing fee of $51,345 was paid by the Company related to this lease. A loss of $202,138 realized on this transaction has been recognized in non-operating expense since the carrying value of the equipment sold exceeded its fair value used as the sale price. The lease matured in July 2010, and the total payments of principal and interest are $8,285,895.

Note 12 - Retirement benefit plans

Regulations in the PRC require the Company to contribute to a defined contribution retirement plan for the benefit of all permanent employees. The Company is required to make contributions to the state retirement plan at 15% to 20% of the monthly base salaries of all current permanent employees. The PRC government is responsible for the administration and benefit liability to retired employees. For the six months ended December 31, 2010 and 2009, the Company made contributions in the amounts of $169,006 and $178,442, respectively to the Company’s retirement plan. For the three months ended December 31, 2010 and 2009, the Company made contributions in the amounts of $30,343 and $90,826, respectively to the Company’s retirement plan.
Note 13 - Subsequent event

In January 2011, the Company obtained a short term loan of $1,517,000 from Industrial and Commercial Bank of China, due November 2011; monthly interest only payments; interest rates are 5.81% per annum, guaranteed by an unrelated third party, unsecured.  

In January 2011, the Company obtained a short term loan of $1,517,000 from Bank of China, due January 2012; monthly interest only payments; interest rates are 5.81% per annum, guaranteed by an unrelated third party, unsecured.

In January 2011, the Company has returned $1,517,000 short term loan from Industrial and Commercial Bank of China and $1,517,000 short term loan from Bank of China.
 
25

 
Item 2.   Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Forward-Looking Statements

The following is a discussion and analysis of the financial condition and results of operations of Shengtai Pharmaceutical, Inc., the ("Company”) and should be read in conjunction with the Company’s financial statements and related notes contained in this Form 10-Q. This Form 10-Q contains forward looking statements that involve risks and uncertainties. You can identify these statements by the use of forward-looking words such as "may,” "will,” "expect,” "anticipate,” "estimate,” "believe,” "continue,” or other similar words. You should read statements that contain these words carefully because they discuss the Company’s future expectations, contain projections of the Company’s future results of operation or financial condition or state other “forward-looking" information. The Company believes that it is important to communicate its future expectations to its investors. However, there may be events in the future that the Company is unable to accurately predict or control. Those events as well as any cautionary language in this Form 10-Q provide examples of risks, uncertainties and events that may cause the Company’s actual results to differ materially from the expectations the Company describes in its forward-looking statements. You should be aware that the occurrence of the events described in this Form 10-Q could have a material adverse effect on the Company’s business, operating results and financial condition. Actual results may differ materially from current expectations.

Overview

We are, through our wholly owned subsidiary, Shengtai Holding Inc., and its wholly owned subsidiary in the People's Republic of China, the ("PRC”), Weifang Shengtai Pharmaceutical Co., Ltd., a leading manufacturer and supplier of pharmaceutical grade glucose in the PRC. We believe that we are a market leader and preferred domestic supplier of pharmaceutical grade glucose, with about 40% market share in Mainland China. We also manufacture glucose, cornstarch and other products for the food and beverage industry.

Our cornstarch production facility used to have a maximum capacity of 300,000 metric tons. As of January 12, 2011, we completed an expansion of our cornstarch production facility and have now increased our production capacity to 400,000 metric tons.  The new production line is used to manufacture non-pharmaceutical grade cornstarch products. This facility is located next to our glucose production plants.  We believe the new cornstarch facility will help us to meet the increasing demand for our cornstarch products and their byproducts. By using the cornstarch manufactured from our own cornstarch production facility, we can ensure our glucose products’ quality and consistency. Also, because our cornstarch manufacturing facility is located next to our glucose manufacturing facilities, we are able to eliminate shipping costs and lower glucose products’ manufacturing costs.

We have been improving dextrose anhydrous and animal feeds production lines and building an additional warehouse to store purchased corn.  The warehouse has been completed and can be used to store an additional 22,000 tons of corn. Because corn prices have been increasing since 2009, the expansion of the warehouse capacity will allow us to store more corn and better control the cost of production.

During the six months ended December 31, 2010, we produced a total of 150,936 metric tons of cornstarch, of which 73,734 metric tons were used to satisfy our own glucose production needs. The excess cornstarch was or will be sold to outside customers in the pharmaceutical, food and beverage and other industries. Cornstarch sales amounted to $28.17 million and accounted for 33.66% of our total net sales for the six months ended December 31, 2010.

Our business may be severely affected by movements in the commodity markets. Corn is the principal raw material for our cornstarch and the price of cornstarch as a commodity tends to follow the price of corn. Corn prices have fluctuated over 10% each year in the last 4 years. Beginning September 2008, corn prices began decreasing due to large corn harvests.  In contrast, by July 2009, corn prices began to increase. This trend continued into 2010. Corn prices for the twelve months ended December 31, 2010 were approximately 18.30% higher than the same period in 2009. Corn prices for the three months ended December 31, 2010 were approximately 12.96% higher than for the same period in 2009. Corn prices for the six months ended December 31, 2010 were approximately 12.13% higher than for the same period in 2009. While it is hard to accurately predict the trend of corn prices, we remain focused on improving our pricing ability and maintaining a stable profit. In the quarter ended December 31, 2010, we completed a new storage facility for corn, and are currently building more corn storage facilities to further improve our ability to store raw material and reduce the impact of fluctuating corn prices.

Recently the Chinese government has placed its own corn reserve into the market to help maintain corn prices. We believe that these government policies have had and will continue to have mixed effects on our operations. Stable corn prices will help maintain the availability of raw materials and tend to stabilize our gross profit margin over time, although market and economic conditions may continue to have negative effects on our operations.

During the six months ended December 31, 2010, we sold a total of 72,323.07 metric tons of glucose, and our sales of pharmaceutical grade glucose and other glucose products was $34.84 million, or 41.63%, of our net sales. During the three months ended December 31, 2010, we sold a total of 40,811 metric tons of glucose, and our sales of pharmaceutical grade glucose and other glucose products was $20.52 million, or 41.29%, of our net sales.

In addition to our pharmaceutical glucose and cornstarch products, we also produce other products such as dextrin, corn embryo, fibers, corn meals, and phytin, which are used in the pharmaceutical industry, for food and beverages, and for other production purposes. The net sales generated from these products was $20.68 million, and constituted approximately 24.71% of our total net sales for the six months ended December 31, 2010.

Management believes that better living standards in China should lead to higher consumption of our pharmaceutical glucose products in the PRC, especially the Dextrose Monohydrate Transfusion Solution. In January 2009, the Chinese government announced its medical stimulus plan to spend a total of 850 billion RMB, or approximately $123 billion, by 2011 to provide universal primary medical services. This plan, together with the continuing economic growth in China, the rising purchasing power of China's domestic market, as well as the public awareness of quality healthcare products, has increased demand for glucose, which is a basic and relatively low-cost element of healthcare in clinics and hospitals.   We expect continued increase of demand of our glucose products.

We believe that production capacity and product quality are key factors in maintaining and improving our competitive position and enhancing our long-term competitiveness. As a result, we emphasize (i) product quality control, (ii) enhancement of operating efficiency and employee competence, (iii) expansion of geographical coverage and diversification of customer base and (iv) expansion of our production capacity utilization.

 
26

 

We have a three-tier quality control system and a well-equipped quality inspection center to ensure timely detection and reprocessing of non-conforming products.

Our glucose production facility passed GMP inspection and our facilities and many of our products are fully certified for GMP, IS09001:2000 and HACCP international quality standards and globally certified Halal, Kosher and NON-GMO IP.

Our sales network presently covers almost all provinces of Mainland China except the Tibet Autonomous Region.

For the six months ended December 31, 2010, we exported products to around 67 countries, with Korea, Indonesia, Thailand, Bangladesh and Pakistan as leading purchasers. For the six months ended December 31, 2010, our international sales comprised approximately 16.96% of our total net sales. During the same period in 2009, our international sales comprised approximately 19.82% of our total net sales. For the three months ended December 31, 2010, our international sales comprised approximately 16.74% of our total net sales.  During the same period in 2009, our international sales comprised approximately 25.06% of our total net sales

Our target customers are drug makers, medical supply companies, medical supply exporters and food and beverage companies. We constantly strive to broaden and diversify our customer base. We believe that a broader customer base will mitigate our reliance on certain major customers. We believe that a broader market for our products can increase demand for our products, reduce our vulnerability to market changes and provide additional areas of growth in the future. For the six months ended December 31, 2010, our top ten customers accounted for 37.66% of our total net sales. For the three months ended December 31, 2010, our top ten customers accounted for 35.86% of our total net sales

Results of Operations

Three Months Ended December 31, 2010 Compared with Three Months Ended December 31, 2009

The following table shows our operating results for the three months ended December 31, 2010 and 2009:

   
Three months
ended
December 31,
2010
   
Three months
ended
December 31,
2009
 
Net Sales
 
$
49,044,856
   
$
28,508,859
 
Cost of Sales
   
43,145,306
     
24,039,512
 
Gross Profit
   
5,899,550
     
4,469,347
 
Selling, General and Administrative Expenses
   
2,103,390
     
2,195,676
 
Income From Operations
   
3,796,160
     
2,273,671
 
Other Expense, Net
   
(252,751
)
   
(746,481)
 
Income Before Provision For Income Taxes
   
3,543,409
     
1,527,190
 
Provision For Income Taxes
   
846,940
     
474,964
 
Net Income
 
$
2,696,468
   
$
1,052,226
 

The following table shows the breakdown of production and sales by product categories, and between self-use by Weifang Shengtai and the sales of cornstarch, for the three months ended December 31, 2010 and 2009:

Products
 
Metric Tons Three
months ended
December 31, 2010
   
Metric Tons
Three months ended
December 31, 2009
   
Net Sales (%)
Three months
ended
December 31,
2010
   
Net Sales (%)
Three months
ended
December 31,
2009
 
                         
                     
20,252,164
   
$
13,893,774
 
Glucose–Sales
   
40,811
     
34,212
   
$
           (41.29
)%
 
$
 (48.73
)%
     
  
     
   
                 
Cornstarch-Self use
   
35,854(45.01
)%
   
35,380(61.78
)%
               
     
 
     
 
     
16,205,781
     
6,999,359
 
Cornstarch-Sales
   
43,809(54.99
)%
   
21,887(38.22
)%
 
$
(33.04
)%
 
$
(24.56
)%
     
 
     
 
                 
Total Cornstarch
   
79,663(100
)%
   
57,267(100
)%
               
                     
12,586,911
     
7,615,726
 
Other Sales
                 
$
(25.67
)%
 
$
(26.71
)%
                     
49,044,856
     
28,508,859
 
Total Sales
                 
$
(100
)%
 
$
 (100
)%

 
27

 

Net sales for the three months ended December 31, 2010 were $49,044,856, an increase of $20,535,997, or 72.03%, compared with the same period in 2009. The increase in net sales primarily resulted from increased demand of our products in all product lines and increased unit selling prices of our glucose and cornstarch products. For the three months ended December 31, 2010 compared to the same period last year, the quantity of our glucose products sold increased about 21.44%, while the average unit selling price of our glucose products increased about 19.42%. For the three months ended December 31, 2010 compared to the same period last year, the quantity of our cornstarch products sold increased about 100%, while the average unit selling price of our cornstarch products increased about 13%.  Particular mention must be made for our Slurry sales which increased approximately $5,361,000 or 660% for the three months ended December 31, 2010 compared to the same period last year. The increase is due to higher production of byproducts and higher demand.  Slurry is a byproduct produced in the process of cornstarch production that when dried, becomes cornstarch.  For the three months ended December 31, 2010 compared to the same period last year, the quantity of our other products sold increased about 63%, while the average unit selling price of our other products maintained the same. The increase in domestic sales is due to the improved economic environment compared with the same period last year, increased demand for glucose products due to the execution of the government stimulus plan, as well as our efforts to develop new clients.  International sales have also increased by 14.89%.

Net sales from exports for the three months ended December 31, 2010 increased approximately14.89% compared with the same period in 2009. The increase is mainly attributable to the recovery of the global economy resulting in an increase in the international demand for our glucose products compared to the same period last year.

Cost of sales for the three months ended December 31, 2010 was $43,145,306, an increase of $19,105,794, or 79.48%, compared with the same period in 2009. The increase in cost of sales was in line with the increase in net sales as well as in line with the increase in the price of corn, our main raw material.

Gross profit for the three months ended December 31, 2010 was $5,899,550, an increase of $1,430,203, or 32.00%, compared with the same period in 2009. The increase of gross profit is mainly in line with the increased sales.

Gross profit margin for the three months ended December 31, 2010 was 12.03%, a decrease from 15.68% for the same period in 2009. The reason for the decrease of gross profit margin is mainly because the price of corn, our main raw material, increased approximately 12% for the three months ended December 31, 2010 compared to the same period last year where the average selling prices did not increase much. The decrease is also due to the change of product mix. In the three months ended December 31, 2010, more low profit products, such as Slurry, were sold compared to the same period last year when more profitable products, such as glucose, accounted for a larger percentage of total revenue. We believe that increased sales of cornstarch and byproducts are bringing more positive cash flow to the Company. We are also working on improving pricing and profit control to improve gross profit margin. At the same time, we have built and are building raw material storage facilities to reduce the impact of fluctuation on the price of our raw materials.

For the three months ended December 31, 2010, selling, general and administrative expenses were $2,103,390, a decrease of $92,286, or 4.20%, compared to $2,195,676 for the three months ended December 31, 2009.  The selling, general, and administrative expenses remain stable as selling expenses increased due to increased sales while general and administrative expenses decreased due to cost control.

We incurred $83,304 and $158,818 non-cash stock option expenses for the three months ended December 31, 2010 and 2009, respectively. The option expenses are included in selling, general and administrative expenses.

Net income for the three months ended December 31, 2010 was $2,696,468, an increase of $1,644,242 compared with $1,052,226 for the same period in 2009. The increase in net income was primarily attributable to the increased sales.

Six Months Ended December 31, 2010 Compared with Six Months Ended December 31, 2009

The following table shows our operating results for the six months ended December 31, 2010 and 2009:

   
Six months
ended
December 31,
2010
   
Six months
ended
December 31,
2009
 
Net Sales
 
$
83,689,428
   
$
51,635,916
 
Cost of Sales
   
71,770,521
     
43,845,213
 
Gross Profit
   
11,918,907
     
7,790,704
 
Selling, General and Administrative Expenses
   
4,683,194
     
4,280,364
 
Income From Operations
   
7,235,713
     
3,510,338
 
Other (Expense) Income, Net
   
(1,371,764
)
   
(1,111,418)
 
Income Before Provision For Income Taxes
   
5,863,949
     
2,398,920
 
Provision For Income Taxes
   
1,524,397
     
562,861
 
Net Income
 
$
4,339,552
   
$
1,836,059
 

 
28

 

The following table shows the breakdown of production and sales by product categories, and between self-use by Weifang Shengtai and the sales of cornstarch, for the six months ended December 31, 2010 and 2009:

Products
 
Metric Tons
Six months ended
December 31, 2010
   
Metric Tons
Six months ended
December 31,
2009
   
Net Sales (%)
Six months
ended
December 31,
2010
   
Net Sales (%)
Six months
ended
December 31,
2009
 
                         
                   
$
34,837,156
   
$
27,401,222
 
Glucose–Sales
   
72,323
     
68,392
   
 
 (41.63
)%
 
 
   (53.07
)%
     
 
                         
Cornstarch-Self use
   
73,734(48.85
)%
   
64,961(63.71
)%                 
     
 
           
$
28,170,845
   
$
11,620,091
 
Cornstarch-Sales
   
77,202(51.15
)%
   
37,003(36.29
)%   
 
 (33.66
)%
 
 
 (22.50 
)%
     
 
                         
Total Cornstarch
   
150,936
 
   
101,964
                 
                   
$
20,681,427
   
$
12,614,603
 
Other Sales
                 
 
 (24.71
)%
 
 
 (24.43
)%
                   
$
83,689,428
   
$
51,635,916
 
Total Sales
                 
 
 (100
)%
 
 
 (100
)%

Net sales for the six months ended December 31, 2010 were $83,689,428, an increase of $32,053,512, or 62.08%, compared with the same period in 2009. The increase in net sales primarily resulted from increased demand of our products in all product lines and increased unit selling prices of our glucose and cornstarch products.  For the six months ended December 31, 2010 compared to the same period last year, the quantity of our glucose products sold increased about 11.44%, while the average unit selling price of our glucose products increased about 18%. For the six months ended December 31, 2010 compared to the same period last year, the quantity of our cornstarch products sold increased about 109%, while the average unit selling price of our cornstarch products increased about 14%.  Especially our Slurry sales increased $7,000,000 or 890% for the six months ended December 31, 2010 compared to the same period last year.  The increase is due to higher production of byproducts and higher demand due to improvment in the global economic environment. For the six months ended December 31, 2010 compared to the same period last year, the quantity of our other products sold increased about 67.39%, while the average unit selling price of our other products maintained the same. The increase in domestic sales is due to the improved economic environment compared with the same period last year, increased demand for glucose products due to the government stimulus plan which invested in healthcare by building more clinics and providing a larger healthcare coverage, as well as our efforts to develop new clients.

Net sales from exports for the six months ended December 31, 2010 increased approximately 38.67% compared with the same period in 2009. The increase is mainly attributable to the recovery of the global economy resulting in an increase in the international demand for our glucose products compared to the same period last year.

Cost of sales for the six months ended December 31, 2010 was $71,770,521, an increase of $27,925,308, or 63.69%, compared with the same period in 2009. The increase in cost of sales was in line with the increase in net sales as well as in line with the increase in price of corn, our main raw material.

Gross profit for the six months ended December 31, 2010 was $11,918,907, an increase of $4,128,203, or 52.99%, compared with the same period in 2009. The increase of gross profit is mainly in line with the increased sales.

Gross profit margin for the six months ended December 31, 2010 was 14.24%, a decrease from 15.09% for the same period in 2009. The reason for the decrease of gross profit margin is mainly because the price of corn, our main raw material, increased approximately 13% for the three months ended December 31, 2010 compared to the same period last year, while the average selling prices did not increase as high.

For the six months ended December 31, 2010, selling, general and administrative expenses were $4,683,194, an increase of  $402,830, or 9.41%, compared to $4,280,364 for the six months ended December 31, 2009.  The increase is mainly due to increased selling expenses such as increased shipping and handling expenses and commission expenses due to increased sales.

 
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We incurred $183,480 and $317,636 non-cash stock option expenses for the six months ended December 31, 2010 and 2009, respectively. The option expenses are included in selling, general and administrative expenses.

Net income for the six months ended December 31, 2010 was $4,339,552, an increase of $2,503,493, or 136.35%, compared with $1,836,059 for the same period in 2009. The increase in net income was primarily attributable to the increased sales.

Liquidity and Capital Resources

Operating Activities

Net cash provided by operating activities for the six months ended December 31, 2010 was $5,120,215, a decrease of 41.37%, or $3,613,399 from $8,733,614 provided by operating activities for the same period in 2009. The decrease of cash provided by the operating activities is mainly due to increased accounts receivable.

Investing Activities

Net cash used in investing activities for the six months ended December 31, 2010 was $6,078,966, a decrease of $2,574,698, or 29.75%, from $8,653,664 provided by investing activities for the same period in 2009. The decrease of cash used in investing activities is mainly due to less expenditure on plant and equipment and construction in process.
.
 Financing Activities

Net cash used for financing activities for the six months ended December 31, 2010 was $2,872,424, compared with $ 4,012,675 used in financing activities for the same period in 2009. The decrease of cash used in investing activities is mainly due to a decrease of restricted cash and more payments of debts.

Loans

Other than our private placement financing in 2007, we have financed our operations primarily through bank loans and operating income. We have a total of $47,724,820 short-term loans outstanding as of December 31, 2010.  The terms of all these short-term loans are for one year. We have never defaulted on any of these loans.

We have $0 of non-current payables as of December 31, 2010 and $3,346,336 as of June 30, 2010.

Guarantees

We have guaranteed certain borrowings of other unrelated third parties including short-term bank loans. The total guaranteed amounts were $4,551,000 as of December 31, 2010. The total amount of guarantees provided to us by unrelated third parties is $4,551,000 as of December 31, 2010.

Future Cash Commitments and Needs

We estimate the need for capital to run new production facilities. The exact amount will be determined based on both the market demand for our products and the time needed for these facilities to run at full capacity. We will carefully review our financial condition and consider financing either with internally generated cash, bank loans or additional equity.  We expect that our proceeds from operating cash flows and our cash balances, together with amounts available under our loans, will be sufficient to meet our anticipated liquidity needs for the next twelve months.

Critical Accounting Policies and Estimates

We have disclosed in the notes to our financial statements those accounting policies that we consider to be significant in determining our results of operations and our financial position which are incorporated by reference herein. We believe that the following reflect the more critical accounting policies that currently affect our financial condition and results of operations.

Revenue recognition

We recognize revenue when the goods are delivered, title has passed, pricing is fixed and collection is reasonably assured. Sales revenue represents the invoiced value of goods, net of value-added tax ("VAT"), and estimated returns of product from customers. Most of our products sold in the PRC are subject to a VAT rate of 17% of the gross sales price or at a rate approved by the Chinese local government. This VAT may be offset by VAT paid by us on raw materials and other materials included in the cost of producing our finished products and certain freight expenses. We allow our customers to return products only if our products are later determined by us to be ineffective. Based on our historical experience over the past three years, product returns have been insignificant throughout all of our product lines. Therefore, we do not estimate deductions or allowance for sales returns. Sales returns are taken against revenue when products are returned from customers. Sales are presented net of any discounts given to customers.

 
30

 

Use of estimates

In preparing the consolidated financial statements in conformity with accounting principles generally accepted in the United States of America, management makes estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the dates of the financial statements, as well as the reported amounts of revenues and expenses during the reporting year. Significant estimates, required by management, include the recoverability of long-lived assets and the valuation of inventories. Actual results could differ from those estimates.

Accounts receivable

In the normal course of business, we extend credit to our customers without requiring collateral or other security interests. Management reviews our accounts receivables at each reporting period to provide for an allowance against accounts receivable for an amount that could become uncollectible. This review process may involve the identification of payment problems with specific customers. We estimate this allowance based on the aging of the accounts receivable, historical collection experience, and other relevant factors, such as changes in the economy and the imposition of regulatory requirements that can have an impact on the industry. These factors continuously change, and can have an impact on collections and our estimation process. These impacts may be material.

 Certain accounts receivable amounts are charged off against allowances after a designated period of collection efforts. Subsequent cash recoveries are recognized as income in the period when they occur.

Property and equipment

Property and equipment are stated at cost less accumulated depreciation. Depreciation is computed using the straight-line method with a 3% residual value over the estimated useful lives of the assets.

Foreign currency translation

Our functional currency is the Renminbi (or "RMB"). Foreign currency transactions are translated at the applicable rates of exchange in effect at the transaction dates. Monetary assets and liabilities denominated in foreign currencies at the balance sheet date are translated at the applicable rates of exchange in effect at that date. Revenues and expenses are translated at the average exchange rates in effect during the reporting period.

Translation adjustments arising from the use of different exchange rates from period to period are included as a component of stockholders’ equity as "Accumulated Other Comprehensive Income.”  Gains and losses resulting from foreign currency translations are included in Accumulated Other Comprehensive Income.
 
 
31

 

Recently Issued Accounting Pronouncements
 
In February 2010, the FASB issued Accounting Standards Update 2010-09, “Subsequent Events (Topic 855): Amendments to Certain Recognition and Disclosure Requirements,” or ASU 2010-09. ASU 2010-09 primarily rescinds the requirement that, for listed companies, financial statements clearly disclose the date through which subsequent events have been evaluated. Subsequent events must still be evaluated through the date of financial statement issuance; however, the disclosure requirement has been removed to avoid conflicts with other SEC guidelines. ASU 2010-09 was effective immediately upon issuance and was adopted in February 2010.

In July 2010, the FASB issued Accounting Standards Update 2010-20, which amend “Receivables” (Topic 310). ASU 2010-20 is intended to provide additional information to assist financial statement users in assessing an entity’s risk exposures and evaluating the adequacy of its allowance for credit losses. The disclosures as of the end of a reporting period are effective for interim and annual reporting periods ending on or after December 15, 2010. The disclosures about activity that occurs during a reporting period are effective for interim and annual reporting periods beginning on or after December 15, 2010. The amendments in ASU 2010-20 encourage, but do not require, comparative disclosures for earlier reporting periods that ended before initial adoption. However, an entity should provide comparative disclosures for those reporting periods ending after initial adoption. We do not expect the adoption of ASU 2010-20 to have a significant impact on our consolidated financial statements.

We have reviewed the Accounting Standards Updates up through 2010-29.

In October 2009, the FASB issued Accounting Standards Update, 2009-13, Revenue Recognition (Topic 605): Multiple Deliverable Revenue Arrangements - A Consensus of the FASB Emerging Issues Task Force.” This update provides application guidance on whether multiple deliverables exist, how the deliverables should be separated and how the consideration should be allocated to one or more units of accounting. This update establishes a selling price hierarchy for determining the selling price of a deliverable. The selling price used for each deliverable will be based on vendor-specific objective evidence, if available, third-party evidence if vendor-specific objective evidence is not available, or estimated selling price if neither vendor-specific or third-party evidence is available. The Company will be required to apply this guidance prospectively for revenue arrangements entered into or materially modified after January 1, 2011; however, earlier application is permitted. Management is in the process of evaluating the impact of adopting this ASC update on the Company’s financial statements.

In January 2010, the FASB issued Accounting Standards Update No. 2010-06 (ASU 2010-06), Fair Value Measurements and Disclosures which amends ASC Topic 820, adding new requirements for disclosures for Levels 1 and 2, separate disclosures of purchases, sales, issuances, and settlements relating to Level 3 measurements and clarification of existing fair value disclosures. ASU 2010-06 is effective for interim and annual periods beginning after December 15, 2009, except for the requirement to provide Level 3 activity of purchases, sales, issuances, and settlements on a gross basis, which will be effective for fiscal year beginning after December 15, 2010 (the Company’s fiscal year 2011); early adoption is permitted. The Company is currently evaluating the impact of adopting ASU -2010-06 on its financial statements.

In July 2010, the FASB issued Accounting Standards Update (ASU) No. 2010-20, “Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses” ASU No. 2010-20 amends the guidance with ASC Topic 310, “Receivables” to facilitate financial statement users’ evaluation of (1) the nature of credit risk inherent in the entity’s portfolio of financing receivables; (2) how that risk is analyzed and assessed in arriving at the allowance for credit losses; and (3) the changes and reasons for those changes in the allowance for credit losses. The amendments in ASU No. 2010-20 also require an entity to provide additional disclosures such as a rollforward schedule of the allowance for credit losses on a portfolio segment basis, credit quality indicators of financing receivables and the aging of past due financing receivables. The adoption of ASU No. 2010-20 did not have an impact on the financial statements and footnotes.
 
Item 3. Quantitative and Qualitative Disclosures about Market Risk.

Not applicable.

Item 4. Controls and Procedures.

Disclosure Controls and Procedures

Mr. Qingtai Liu, our Chief Executive Officer, and Mr. Wang, our current controller, have evaluated the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, as of the end of the period covered by this Report.  Based on that evaluation which, among other things, identified personnel turnover in the areas concerned, mainly referring to our chief financial officer’s resignations during the last two years, the Company’s officers concluded that disclosure controls and procedures were not effective and were not adequately designed to ensure that the information required to be disclosed by us in reports submitted under the Exchange Act are recorded, processed, summarized and reported within the time periods specified in the applicable rules and forms and that such information was accumulated and communicated to our chief executive officer and chief financial officer in a manner that allowed for timely decisions regarding required disclosure.

Changes in Internal Control over Financial Reporting

During the quarter ended December 31, 2010, other than the impacts by the resignations of our chief financial officer, there has been no material change in internal control over financial reporting that has materially affected, or is reasonably likely to materially affect our internal control over financial reporting.

A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control systems are met. Because of the inherent limitations in all control systems no evaluation of controls can provide absolute assurance that all control issues, if any, within a company have been detected. Such limitations include the fact that human judgment in decision-making can be faulty and that breakdowns in internal control can occur because of human failures, such as simple errors or mistakes or intentional circumvention of the established process.

PART II - OTHER INFORMATION

Item 1. Legal Proceedings.

From time to time, we become involved in various lawsuits and legal proceedings that arise in the ordinary course of business. While the ultimate outcome of these lawsuits and legal proceedings cannot be determined at this time, it is the opinion of management that the resolution of these actions will not have a material adverse effect on our financial condition, results of operations or cash flows.

Item 1A. Risk Factors.

Not Applicable.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.

None.

Item 3.  Defaults upon Senior Securities.

None.
 
Item 4.  (Removed and Reserved).

Item 5.  Other Information.

Not Applicable.

 
32

 

Item 6.  Exhibits.

Exhibit No.
 
Title of Document
     
31.1
 
Certification of the Principal Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
     
31.2
 
Certification of the Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
     
32.1
 
Certification of the Principal Executive Officer pursuant to U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
     
32.2
 
Certification of the Principal Financial Officer pursuant to U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 
33

 

SIGNATURES

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

Date: February 14, 2011

 
SHENGTAI PHARMACEUTICAL, INC.
 
       
 
By:
/s/ Qingtai Liu
 
   
Qingtai Liu
 
   
Chief Executive Officer
 
   
(Principal Executive Officer)
 
       
 
By:
/s/ Yongqiang Wang
 
   
Yongqiang Wang
 
   
Financial Controller
 
   
(Principal Financial Officer)
 

 
34